Q4 2019 Earnings Call

This time all participants are in listen only mode. A brief question answer session will follow the formal presentation. They don't want to acquire operator assistance. During the conference. Please press star zero on your telephone keypad.

A reminder, this conference is being recorded.

It is now my pleasure introduced Jess Lubert, Vice President Investor Relations. Thank you. Please begin.

Thank you operator, good afternoon, and welcome to our fourth quarter 2019 conference call. Joining me today, our Rami Rahim Chief Executive Officer, and can Miller Chief Financial Officer.

Today's call contain certain forward looking statements based on our current expectations.

Statements are subject to risks and uncertainties and actual results might differ materially is western discussion on most recent 10-Q. The press release CFO commentary furnished with our 8-K filed today and in our other SEC filings are forward looking statements speak only as of today and Juniper undertakes no obligation to update any.

Forward looking statements our discussion today will include non-GAAP financial results.

Reconciliation information can be found on the Investor Relations section of our website under financial reports.

Terry and why we consider non-GAAP information a useful view of the Companys financial results is included in today's press release.

Following our prepared remarks, we will take questions. Please limit yourself to one question and one follow up with.

With that I'll now hand, the call over to Rami.

Thank you good afternoon, everyone. We reported solid results during the December quarter total revenue of 1.208 billion was above the midpoint of our guidance and we returned to growth on a year over year basis strength for the quarter was driven by our cloud and enterprise verticals, which more than offset.

Expected weakness within our service provider business.

non-GAAP earnings per share of 58 cents came in a penny above the midpoint of our forecast.

Topline strength flowed through to the bottom line.

Where are your 2019 played out largely as we anticipated and we were encouraged to finish the year I know.

Some of the highlights from the year included a third consecutive your enterprise growth, including a record quarterly performance during the December quarter.

Returned to year over year growth in the cloud vertical following a difficult product transition, which we believe will position us for additional growth in the years to come.

The successful acquisition of missed which has already exceeding our initial expectations and have the potential to have a material positive impact on ARPU you know.

Corn basis.

Strong software growth that we expect is likely to continue due to the value of our box platforms like Collins rail and efforts to better monetize the value of our existing solution.

And significant progress enhancing our go to market organization, which we believe will help us capitalize on the various technology innovations, we are bringing to market and gain share as many of our markets transition over the next few years.

We expect to build on many of these accomplishments in 2020.

We believe we are executing well positioned to sustainably grow the business starting this year.

While this will require some incremental investment, particularly in go to market. We remain committed to growing non-GAAP earnings this year and expect the investments we're making in 2020 will create the topline momentum needed to drive incremental leverage and earnings growth in future years.

Now I'd like to provide some insight into the quarter and addressed some of the key developments, we are seeing within each of our core verticals.

Starting with cloud, we experienced better than expected results during the December quarter as the business grew 18% year over year, an increase year over year for third consecutive quarter.

We continue to see momentum within our customers wide area networks, particularly for some of our switching products. This past quarter, although our cloud routing business also saw double digit growth year over year.

Order trends remain healthy and despite some likely seasonality we are optimistic regarding our ability to once again grow this business on a year over year basis during the March quarter.

We are encouraged by the success, we're seeing with some of our largest cloud customers and continue to believe we're positioned to grow with their capacity requirements now that the MX to pgx transition is largely behind us.

That said, we have also been experiencing growth with tier two cloud providers and believe we're gaining share as many of these accounts increasingly leveraging their own private clouds.

While our existing cloud use cases should present modest growth opportunities for us over the next few years, we're very much focused on leveraging the 400 gig cycle to capture Hyperscale switching opportunities inside the data center, where historically, we have maintained limited share.

On this last point, we believe we have delivered the systems silicon and software needed to win Hyperscale switching share during the 400 gig cycle and plan to introduce additional solutions and capabilities over the next few quarters.

These solutions are now we are customers labs, and we remain optimistic regarding our ability to secure wins.

While early 400 gig deployments are expected to begin during the second half of the year, we do not expect material revenue to materialize until 2021 due to the availability and cost of optics.

We achieved record enterprise results in the December quarter with that business growing 2% year over year, despite the difficult comparison.

These results were better than expected we were pleased to growth despite a year over year decline in our federal business, which moderated following several strong quarters.

We believe our portfolio of enterprise solutions is truly differentiated and resonating in the market, which is driving increased confidence that the go to market investments, we're making should position us to take share and grow this business in the years to come even in a challenging macro environment.

Some of the items driving confidence in their enterprise outlook includes the following.

First I couldn't be more pleased by the momentum, we're seeing with men and the opportunity to bring AI to the broader enterprise market.

I missed it was a truly differentiated platform that offers industry, leading scale and AI capabilities.

MS. <unk> engine leverage is more than four years of advanced learning to help customers improved network operation and the user experience as compared to our peers would simply focused on uptime of the network access points routers and switches.

Mrs capabilities are clearly resonating in the market.

Its customer base grew more than 150% year over year in the December quarter, an aggregate bookings permit and the direct pull through it enables exceeded $100 million run rate on an annualized basis.

Well I missed is already exceeding our initial expectations. We believe we have just scratched the surface of miss potential and the impact is likely to happen on the broader juniper portfolio.

At this point, we're seeing strong initial demand for our recently launched missed wired assurance that brings cloud management capabilities to the ex portfolio.

This capability at all really enabled us to secure X wins with several fortune 100 accounts, including a fortune 10. The previously we're not juniper, yes customers.

We plan to mystify additional elements of our switching and security portfolio through the year, which we believe should create incremental pull through opportunities in future periods.

We are investing to further monetized miss with our existing customer base and capture new logos as the industry transitions to why Fysixteen and the I driven enterprise.

Second our enterprise switching business is being healthy momentum growing both quarter over quarter and year over year in the December quarter, with our QFX did a sensor products experiencing record orders.

We believe our industry, leading N VXLAN capabilities and consequently fabric management software platform are resonating in the datacenter market and should position us to grow this business moving forward, while our yes portfolio declined year over year sequential momentum has been strong now for several quarters and we.

Back to see better year over year trends on a go forward basis as the productivity of our go to market organization improves after last year's organizational transformation and the Miss pull through we are starting to see further materializes.

Third our secure SD went capabilities are seeing healthy traction.

Well this opportunity remains in the early innings, we believe our ability to offer cloud management security and why find capabilities is resonating with many of our customers and should not only position us to gain share it and what is expected to be a large in fast growing market, but also presents another catalyst that helps pull through our broader.

Campus networking portfolio.

Our service provider business remains challenged however, we experienced healthy quarter over quarter growth in the December quarter, and the pace of year over year decline began to moderate which is a trend that we expect to continue during the upcoming year.

The move of our Amex body line card from qualifications to deployment the success of our conch real telco cloud platform, hi, insecurity opportunities and the availability of U.S. products are amongst some of the reasons, we expect our service butter vertical to present less of a headwind in future periods.

While our security revenue slightly declined year over year during Q4.

Our security orders grew 24% quarter over quarter, and 3% year over year and came in at the highest levels in last four years.

We saw notable strength in our mid range portfolio, which saw orders increased nearly 35% year over year and we remain optimistic regarding the outlook for our high end offerings.

We believe our security portfolio is highly competitive which was recently validated by NSS labs, which provided a recommended rating for high end data center, offering and Gartner, which ranked us as a top supplier for both data center and distributed enterprise security use cases, it's critical capabilities report.

We are encouraged by the momentum we are seeing and the success of our connected security strategy, which focuses on bundling security with our traditional networking platforms.

I think customers are increasingly looking to consume security as part of a networking solution and believe we are well positioned to capitalize on the trend.

We're continuing to see success in our software business, which grew 25% year over year and accounted for more than 12% of our revenue during the December quarter.

While much of our software revenue today's driven by on box software licenses.

I'll walk software orders increased more than 90% year over year and off box subscriptions increased more than 170% year over year, Beauticontrol security subscriptions and missed.

Based on the momentum we're seeing we believe our software as a percentage of sales will continue to increase overtime, especially a subscription based pricing model become more pervasive and gained traction in the market.

Not to be overlooked our services business delivered a record quarter and the business grew more than 2% <unk> full year basis.

Our services team continues to execute extremely well with improved attach rates and renewal the primary factor driving strength in both the quarter and the year.

Our service pipeline remains healthy and we remain confident in our ability to once again grow this business during the upcoming year.

Finally, I'd like to highlight that we are making solid progress in our sales transformation initiatives.

Our population of quota carrying sales reps is up by approximately 20% from the trough levels. We experienced during the Q1 2019, and we are making solid progress against our productivity goals.

We believe our investments in go to market should create tailwinds through the course of the year and presents an important revenue driver that helps us capitalize on the various innovations, we're bringing to market, particularly within the enterprise vertical during the upcoming year.

I would like to extend my thanks to our customers partners and shareholders for their continued support and confidence in juniper I, especially want to thank our employees for their hard work and dedication, which is essential to creating value for our stakeholders I will now turn the call over to can who will discuss our quarterly financial results in more detail.

Ill.

Thank you Rami and good afternoon, everyone.

I'll start by discussing our fourth quarter results and then cover the full fiscal year and end with some color on our outlook.

We ended the fourth quarter with $1.208 billion in revenue and non-GAAP earnings per share of 58 cents, both above the midpoint of guidance.

Higher than midpoint results were driven by greater than anticipated strength in cloud and to a lesser extent enterprise.

As we expected we're exiting the year stronger than we entered we're pleased with our 2% you ever your growth in total revenue.

Looking at a revenue by vertical on a year over year basis cloud increased 18% and enterprise increased 2% while service provider declined to 5%.

On a sequential basis, all verticals all technologies in all geographies are up.

Service provider increased 9% sequentially with growth across all products and services.

Enterprise growth of 7% on a sequential basis was primarily driven by switching.

Our cloud business increased 3% on a sequential basis, primarily driven by routing and services.

From a technology perspective routing grew 4% switching increased 11% and security grew 7% sequentially.

Our services business increased 3% year over year, and 7% sequentially, primarily due to strong renewals.

As Rami mentioned, we saw continued solid performance from our software offerings, which increased 25% year over year and it was more than 12% of total revenue in the quarter.

In reviewing our top 10 customers for the quarter three ever cloud six were service provider and one wasn't enterprise.

Product deferred revenue was $133 million up 3% sequentially and down 8% year over year due to the timing of the delivery of contractual commitments.

non-GAAP operating expenses increased 4% year over year and 1% sequentially.

Cash flow from operations was $96 million down sequentially and year over year, primarily due to timing differences related to payments to suppliers and customer collections, we expect to see a rebound in cash flow in the first quarter, one of a likely exceed $200 million.

We paid $64 million in dividends, reflecting a quarterly dividend of 19 cents per share.

We entered into an accelerated share repurchase program for $200 million in shares which was completed earlier this month.

Moving onto the results for the full year.

Fiscal 2019, largely played out as we expected with revenue declining 4% versus last year.

While our service provider business remain challenged declining 12% or enterprise business grew for the third consecutive year and our cloud business returned to full year growth.

On a full year basis security grew 3% year over year, and our services business grew 2%.

Software grew 16% I was greater than 10% of total revenue for the full year.

However, routing declined to 12% and switching declined 4% versus 2018, both result for primarily due to weakness and service provider.

In reviewing our top 10 customers for the year four of our cloud five or service provider and one wasn't enterprise.

non-GAAP gross margin expanded over 20 basis points due to the strength in our service margin, which more than offset lower product volume and China tariffs.

Our focus on discipline non-GAAP operating expense management continued with the decline in operating expenses of $10 million.

non-GAAP diluted earnings per share declined 9%.

For the year, we had cash flow from operations of $529 million.

During 2019, we took a balanced approach to capital allocation.

From a return to shareholder perspective, we repurchased $550 million with his shares and paid $260 million in dividends totaling 193% of free cash flow.

In addition, we used approximately $360 million to acquire missed and approximately $450 million to pay down debt.

Before we move onto Q and I would like to provide some color on our guidance, which you could find detailed in the CFO commentary available on our website.

At the midpoint of our first quarter guidance, we expect yearoveryear growth in both revenue and non-GAAP earnings per share.

Beyond the first quarter, we expect revenue non-GAAP earnings per share to grow on a sequential basis, and we expect modest growth for the full year.

We expect non-GAAP gross margins to experience normal seasonal patterns in the first quarter and improve with volume throughout the course of the year.

While non-GAAP gross margins can be difficult to predict and can be impacted by deal and customer mix. We currently expect full year gross margin to be flat to slightly up versus 2019 levels.

We expect first quarter non-GAAP operating expense to increase sequentially due to the reset a variable compensation and typical seasonal increase in French costs.

Through the course of 2020, we expect quarterly non-GAAP operating expense to remain near Q1 levels.

While we expect non-GAAP operating expense to be up on a full year basis as we invest to take advantage of market opportunities. We remain committed to discipline operating expense management and expect earnings to grow and 2020.

For 2020, we expect non-GAAP tax rate on a worldwide earnings to be 19% plus or minus 1%.

Finally, our board of directors has declared a 5% entries in our quarterly cash dividend to 20 cents per share to be paid this quarter to stockholders of record.

In closing I would like to thank our team for their continued dedication and commitment to juniper success now like to open the call for questions.

Thank you well not be conducting a question answer session. If you like to ask a question. Please press star one on your telephone keypad economists in total indicate your line is in the question Q.

Start to feel that to move your question from the Q.

Since using speaker equipment, it maybe necessary to pick up your handset before pressing the star keys.

And please poll for questions.

And thank you all our first question comes on line of Ittai Kidron with Oppenheimer and company. Please proceed.

Thanks, Hey, guys, so nice to see the cloud business clicking again.

Can you talk about visibility and the club business and revenue concentration there how has that.

Improved and you know as 400 kicks in.

No you're talking about more is it next year event, but do you expect that ramp to be a lumpy how should we think about that.

Yes. Thanks for the question. So first that needless to say, it's great to see the performance in our cloud business Newport timeframe. The year largely played out as we expected I in fact, probably talk a little bit a stronger results in the Q4 timeframe than what we had originally anticipated.

The success in the Hyperscalers always going to be concentrated in capex levels in that segment are definitely concentrated however, I'm pleased with the fact that we saw successes across a broad number of customers not just within the highest hyperscalers, but also in tier two cloud, where I think we're doing actually quite well.

Also the breadth of the technologies with strength in both switching and routing that we're quite pleased with Oh, we have a unique position when it comes to the routing footprint that we retain into Hyperscale space.

And we bought hard to retain as you know with the truck product transition that we've undertaken over the last year to have a at this point yeah. I think that is largely behind us and we're now in a situation where the strength of the business. The momentum is going to be very much based on the timing of deployment so that I think.

So as to sort of mid to low single digit growth type rates in the cloud segment in the in the 2020 timeframe certainly as you get into the 400 gig deployments and in particular in the data center in DC, hi that pose that presents a much bigger opportunity for us to go after and.

We are doing just that I mean are all of our focus our energy our investments are going into the 400 gig system. The software. The specific features that our customers are requiring and we're engaging very deeply with our customers in order to have a very good shot at not just you know getting our fair share, but more than our fair share.

Sure in that segment and timing of that is gonna be closer to the ended the year into next year for where meaningful revenue happens and that's largely tied to the timing of the projects within hyperscale as well as the timing and availability of 400 Gigoptix.

Got it and as a follow up.

It's very nice to see that missed is kind of pulling the X, but maybe can you tell us. He is that the mode of operation do you lead with a bundle right now or Miss salespeople, <unk> tried to make introductions or or and vice versa. How much of this is truly the preferred path for you a into customers.

That's great question I think there's really two sales plays that we undertake when it comes to the enterprise based and the specific customer and their their requirements at present sub one sales play is very much data center oriented and it's a it is around satish.

As flying the sort of highly automated private cloud.

Datacenter with a simple fabric management high performance N VX land type.

Functionality that I think we have real strength and we saw a really good momentum and the data center switching space in the Q4 timeframe in fact record orders for the Q effects.

In in Q4, largely driven by both cloud as well as a the enterprise.

The second sales plays very much aligned with what you're talking about which is around the count the campus.

And there we are finding a lot of success and leaving witness the highly differentiated cloud based management AI, driven simplicity and user experience that now allows us to start the conversation to open the door and then to insert.

Switching, which I think is leading to them the sequential performance that we're starting to see with the extra folio and I'll just mention that that we just recently introduced functionality that makes that sales play not just one of a commercial play where we start with one product and then you know leads us to a conversation.

But the other it very much a technical tie and where the mid cloud the management, the AI analytics and insurance now actually technically ties in the ex where you get the customer the ability to look at the performance of their network across both wired and wireless and I think that's a very unique offering that we have now.

Now in the market.

Thank you. Our next question comes from lineup I met their Jani with Evercore. Please proceed.

Thanks, a lot of taking my question I have two as well I guess first I'm just from the free cash flow numbers. All historically had in December what is being one of the better free cash flow quarter speed guys.

Fortunately forces net income was fairly low.

Couple of what happened in the December quarter free cash when should we expect that to pickup as you go into the March quarter.

Yes, a free cash flow was down a little bit compared to our normal kind of seasonal average primarily just due to timing of of both purchases as well as some cash collections from customers. We did see a build up in deferred revenue. When we saw some strong bookings, particularly in a services side service renewals and you'll see our DSL also went up and the.

Q4 time period, which is not abnormal we absolutely expect that timing to revert we expect Q1 to be a strong cash flow quarter for us in fact, I would expect it to exceed $200 million in Q1. So the cash the cash flow that you were expecting you see in Q4 was just pushed out a bit ended the Q1 timing.

Perfect really appreciate that and then I guess another just follow up on when I listen to your calendar 20 commentary around it in gross margins being flat to slightly off Opex I think he said would be up year over year as well up what does that embed from a revenue perspective. He got does that kinda based on flat volumes or does that factor in some revenue leverage as well because I guess I would think if revenues are.

We would see better leverage, especially in the gross margin line.

Yes. The revenue we were comfortable with current street estimates for 2020, which are looking for about 1% growth on from a gross margin perspective, we think flat to slightly up volume a would help and you know, but modest growth called 1% level. If it's not going have a tremendous impact on gross margins ought to expect flat to slightly up and it goes margin perspective, we are driving for.

Full year earnings growth and 2020 as well.

Perfect. Thanks, a lot.

Thank you. Our next question comes from one of the Samik Chatterjee with JP Morgan. Please proceed.

Hi, Thanks for taking the question if I could just start off with on the telecom vertical and kind of what's embedded in terms of revenue outlook. All as you mentioned your full year outlook is for modest revenue growth, but how you're thinking about the telecom vertical within that and what could potentially drive some upside to the expectations what do you need.

See you from the service providers.

Yes, certainly samik.

So you know, we actually saw a pretty good recovery on a sequential basis and tell us in telcos in the service provider vertical in Q4 2019, largely played out as we expected you know we had expected the second half to be stronger than the first half not essentially panned out.

As expected a lot of the momentum wasn't the Q4 timeframe.

A couple of reasons for this one is timing of orders timing a project that we had visibility into.

There's only so much time better surface water can go without having to invest in their network. So that certainly benefited us the other thing that I'd I'd like to call out to the breadth of the solutions that we're now selling into the telco domain, where we have obviously very tight relationships and strategic.

Discussions with is increasing so not only are we now selling routing technology, which is our traditional business, but we saw good strength in switching and security or not to mention in software in particular on the cloud.

And telco cloud solutions that we're now offering across a large number of customers. So when I when I extrapolate out into it into 2020, you know I would not return I would not estimate or predict a return to growth.

I think growth is you know in the card for further out in a couple of years timeframe, but for 2020, I'd say less headwinds.

Supported by some of these other solutions that we are now introducing and selling to our telco customers.

I do think that a there are gonna be some catalyst out there that we can leverage fiveg. Although the timing is somewhat unpredictable I do believe it's going to be big and it's going to be a catalyst for investments that will play out over a number of years, our metro portfolio, which will start to come together for us. This year later this year.

Yeah, I think will be good our partnerships our strategic partnerships with companies like Ericsson I think starts to help.

Not to mention just the portfolio. So we introduced last year, some pretty meaningful enhancements and upgrades to our MX portfolio and those have gone through certifications and I think we've now started getting into the early deployment I think starts to benefit us throughout this year.

Got it if I can just follow up on the last one is called you had mentioned you. It you were seeing some weakness in the bookings from the enterprise customers you had revenue growth would be in price foot on this quarter, but if you can just kind of help us with what it would be trends you saw play out during the quarter <unk> how did it.

And the quarter in terms of bookings how did you end the quota.

Yes, we did mention in Q3 that we were seeing some more caution from some of our enterprise customers and I'd say that Q4 played out largely as Q3 did there.

There is some level of caution that is out there that is maybe delaying some orders. However look I mean, we had a good enterprise quarter I think even in a scenario where there is weakness in the macro our share in the enterprise vertical leaves a lot of room for growth and I have often.

Isn't based on the strength of our portfolio, especially around the data center switching portfolio as well as the campus wired wireless switching solution as well and coupled that with the hard work the that we did over the last year and restructure.

During our salesforce cutting in order to invest in front line sellers that we're now starting to see the benefit of so as I mentioned in my prepared remarks compared to trough levels over the last year, where we thought we are now at 20% increase in a number of quota carrying sales reps.

Our that are out already now many of them are relatively new our and are still in the process of becoming fully productive I think as.

That happens throughout this year, we're going to start we're going to really benefit from it especially in the second half of the year.

Got it. Thank you thanks for taking my questions.

Thank you.

Thank you. Our next question comes your line of Simon Leopold with Raymond James. Please proceed.

Great. Thanks for taking the questions I wanted to attest to the first one is just maybe if we could double click a little bit on what's occurring in your gross margins in other words, I guess I'm trying to get a better understanding of how much of the.

Forecast for the year as well as the March quarter is related to mix geographies customer mix product mix I know all of these sort of fact trend, but maybe if you could help us with a bridge take to get an idea of how to model that.

Yes, so deal mix is very much a factor I would say if you look at the full year basis 2019 versus 2018, the primary driver to the drop in product gross margin was both tariff and volume so mix did not play a big factor on full year basis.

19% 18, however on in a quarterly basis. So for example, Q3 last year versus Q4 the quarter. We just ended you did see some negative mix trends that impacted the margin marginally so any given quarter you know, it's going up it's going to its going to vary based on deal mix on a kind of a more longer term period, we're managing it could.

Right effectively we did see some headwinds last year with tariffs as well as volumes being down those are really the two drivers and the product gross margin. We saw tremendous strength in service gross margin, which enable us to deliver you know fairly fairly flattish overall gross margins for the company.

And then as follow up just want to get a better sense of of the 400 gig market opportunity. It sounds like you're a little bit a more pessimistic about the timing pushing the volume into 2021, and I guess one of things I'm trying to understand here is what will you be shipping essentially 400 gig capable Chad.

Season in essentially establishing a footprint that might be a quick with hundred gigoptix waiting for the optics to to be.

At the right price point or does the whole product cycle really go along with the optics availability and it's really a 2021 cycle hopefully that makes sense.

It's it certainly doesn't.

Only be clear I think that's what we're seeing with respect to the timing of 400 gig.

Oh, Yeah solution deployments the opportunity that is there for us is no not different than anything that our peers are seeing as well.

We've done everything that is in our control right now I mean, retaining our routing footprint was necessary because that gives us an amazing platform off of which to increase our relevance within the cloud vertical and we've done that in terms of the solutions and the product we already have our first for.

Hundred gig systems that are in the market based on both custom and merchant silicon the new operating system. That's very much developed with our cloud vertical in mind with the kind of modularity analytics native capability. The program ability has now seen its way into the market. We are very much thing.

Gauged with our customers in early deployments in early you know lab certification.

And the timing is essentially tied to the timing that our customers are looking to deployed and yes optics play that a big role in the timing and not just the availability of the optics, but also in the the economics of those optics.

Great. Thank you very much.

Thank you.

Thank you.

Our next question comes on line of Aaron Records with Wells Fargo. Please proceed.

Thanks for taking the questions. If I can start just on a on a strategic basis. One of your biggest competitors talk recently about selling a silicon directly into the cloud verticals, obviously, given whats your proprietary silicon strategy I'm just curious on how you think about whether or not that would present an opportunity for juniper do something similar.

Or or how you see that engagement, possibly a with some of the cloud customers I do a follow up.

Yeah. Thanks for the question Aaron I'll start by just saying that or you know I have a ton of confidence and I certainly have a lot of experience and background in this and this domain from my engineering days here at Juniper in our silicon strategy in our silicon execution in the strength in the competitiveness of our silicon products.

The are you know that make their way into a variety of our systems.

In particular, when it comes to 400 gig.

I think we have a unique offering already in the market, but still to come in terms of the full breadth of the solution that we are bringing to market based both on merchant silicon in certain classes of switching silicon, but also on custom silicon that we've developed over the last several years when it comes to sort of efficiency performance.

Hold with security and encryption, we really believed that we have done something very special here, so very well equipped to deal with what we know is a competitive environment.

This aggregation selling software and silicon separately is not a new concept in fact, I believe architecturally we've done a lot over the last couple of years to disaggregate, our software from ours from our silicon in a way that allows us to achieve much more nimbleness and how we develop.

Our systems and can move and adapt to different silicon offerings.

That said in terms of the business model of selling software in silicon separately. We certainly we have experienced good we have not done this for quite some time.

And in selling software separately from the system than from Silicon. We did we started this doing.

We started this years ago as far as selling silicon separately, you know, while I have confidence in our silicon itself that business model I'm not sure that would there be a huge market for it or quite frankly, so it's something that we would be open to something that we would take a close look at going forward, but for now we're going to be very focus.

On selling the system the software and the silicon photonics capabilities when they hit the market later this year.

Yeah, that's great answer and then just as a quick follow up just sort of model basis back to the gross margin you know when I look at gross margin here. This last quarter you saw a pretty healthy services gross margin was or onetime items, an ad or how do we think about the services gross margin going forward relative to the I think it was 65% you just reported.

Yes, the services gross margin clearly benefited from the very strong services revenue as you saw it.

Actually a little bit more lift there than we expected began a quarter or the cost is little more fixed most of our most of our cost of services is really our you know service Jack facilities labs et cetera. So we're seeing a relatively stable cost line as revenue ramps sequentially as it did last year you didn't see a bigger margin normal I would expect.

Got to come down a bit in Q1 as as revenue seasonally will come down for services and the cost will remain a kind of it fixed levels.

Perfect. Thank you.

Okay.

Thank you. Our next question comes on line of just kept all with Nomura. Please proceed.

Yes, Thank you and Romeo moving to Peel back that a that answer on the independent chip a little bit why why don't you think that there would be a market for for Standalone silicon and I guess the broader question with that is do you feel like the Cisco announcement makes the.

Web scale market more or potentially less competitive heading into the 400 GE cycle.

I think the cloud demand has always been a very competitive environment. Then, let's just say that we are very used to and comfortable operating in a in in that competitive environment than doing well.

Despite the competition you know again I'll just reiterate.

Part of my answer I think that there is a large market out there for selling the software many of our customers are looking at buying especially off box software the opportunities. So as you know and network operating system disaggregated from Silicon we have a ton of experience here is limited there are only a few number of customers though.

I'm interested in that model lot of them talked about it but ultimately they desire the simplicity of A.O. Smith of a system that include the software and in some case merchant silicon in other cases, and custom silicon as far as I'm selling selling silicon separately like I said the focus for US right now is on.

A technology that we believe has breadth and you know in demand and that is in the 400 gig silicon photonics space as far as silicon forwarding engines and switch silicon is concerned.

Dose that if we entered that market, we're going to see the other Oems being customers of ours, so that really limits that to the cloud providers themselves and based on our conversation the very specific engagements that we're having with them I think for now the demand is more in the converged systems and you know meeting their requirements in terms of.

The program ability the telemetry capabilities the power efficiency.

Performance of of their requirements that we are confident that were satisfying.

Okay. Thank you.

Then you seem to say that tier two cloud was an area of success for you how much runway do you have and that is that a is that a sustainable theme for 2020 and beyond.

I think so yes, because what we're seeing with tier two cloud is first there are a number of customers that we've seen sort of pivot back to a strategy, where they want to deploy their own datacenters as opposed to just moving to our embracing the public cloud.

Offering so that certainly is a trend that will help tier two specifically second not only did we retain customers and sort of strength and the build out of data centers worldwide, but we've won some new logos that I think will help us in a in coming quarters.

Thank you. Our next question comes from a line of Alex Henderson with Needham. Please proceed.

Thank you very much it just wanted to make sure I understood the mechanics around what tier, suggesting for the 2020 timeframe it sounds like a 2% revenue growth.

Modest increase in gross margins.

Are you said, suggesting that your opex increases will be roughly comparable to the revenue growth and therefore, the only margin leverage you'll have a slight improvement in gross margin hence.

Operating profit growth fairly consistent with the revenue growth is that the way we shouldn't be reading the the commentary on 2020.

Yes, so we're comfortable with the current street a revenue estimates for 2020, which are approximately 1% revenue growth I believe it that at those kind of revenue numbers. We should expect gross margin be flat to slightly up opex will be up on a full year basis.

I do expect discontinued it'd be opportunistic with a capital return program as well with what's your buyback. So the combination of that we believe will get us to do earnings growth on a full year basis next year or this year.

Okay, and just going back to the commentary around Oh, the switching market.

Is your co package to or technology, or helping you penetrate into.

Any of the.

Tier one cloud companies to where they want to get experience with that a co packaging functionality a it seems that that's one of the distinguishing characteristics of your Hunter get products. Currently obviously it would be better to to learn about it at 100 gig then tried to deploy that 400 gig.

Hi, Alex I I'm not sure I fully understand the question, but when I think co packaging really that comes to co packaging of optics and switching silicon that's something that's more a future trend that we do believe and but it's not a here and now it's actually pick a number of years before that becomes a necessity.

He or something that technically or economically feasible, having said that we do very much believed that our silicon photonic technology. Our IP that we have that were initially embracing to put into Standalone Pluggable transceiver is has future.

Clickability into co packaging and that is an outcome that we very much are working towards but it's certainly a lot of here and now it's really more of a future trends.

Thank you.

My question.

Thank you. Our next question comes from light of Rod Hall with Goldman Sachs. Please proceed.

Hi, Thank you for taking my question does Ashwin on behalf of fraud I got one two part question and one another question on the APAC first on foreign a gig.

Rami can you give us an update on the timing of 400 gig silicon photonics on any update on the progress there.

Instead of related to that.

I wanted to check if you guys, who are willing to sell 400 gig boxs Toronto someone out someone else a softer on it.

And how to follow up.

Yes, thanks, Ashwin, so silicon photonics, a lot of progress has been made.

The the Big challenge with Silicon Photonics is not so much about the technology itself I believe from a technology standpoint, we have something that's unique highly differentiated in them in the market today or relative to what's out there in the market today.

The challenges around production manufacturing in large volumes and what we have done over the last several months now is that we have.

Dropped off strategic partnerships with strong manufacturing a entities companies baghouses that specialize in this type of technology that will mitigate the risks associated with the large scale manufacturing of the technology. So you know at this point I feel good.

About the differentiation I feel good.

And confident that we're going to get to a solution that we can shipped to our customers. Later this year and this is not easy you. This is certainly a lot of technical hurdles that that are in the way, but I do believe that were overcoming one by one and like I said before the end of year, we should hover first products in the market.

Or is your question Yeah, a question about 400 gig.

So it is it's an interesting question I actually think the demand.

There is a greater demand for.

Software network operating system software that will sit on white box hardware than there is for something that is the other way around.

That said what there is of course, a an interest in by some of our cloud customers. In particular is as very efficient implementation of Sonic on a system that we build that could either be merchant or in some cases custom.

And so sonic as sort of this lightweight nos.

Network operating system.

That some of our cloud customers are asking for is something that we have very much the embraced we've invested in we demoed.

Versions of this on our systems that I think have demonstrated so our customers how seriously we are and there's more to come in this space.

Take care and just as a follow up.

On Asia Pacific and the revenue code there I think that that region has been declining for about eight quarters trade now.

Just wondering what's driving that and what could sort of turn around the business there.

Yeah, I'll take that so.

I think part of this has to do with the fact that some of our big customers in APAC region. We really had a we had some level of concentration, especially in the telco space and to a lesser degree in the cloud space.

That you know just.

We're not spending as much over the last few quarters and as they had done traditionally and that resulted in some weakness.

I also just will acknowledge I think we've had some execution challenges.

In Asia Pacific that we've had to address and we are actually I'm going to be announcing a new way APAC leader of barely imminently at this point.

I would just add that we did see two consecutive quarters of sequential growth in Asia Pac and we did see enterprise up on a year on year basis. So we are seeing some pockets of strength there I think theres more to come I would expect all of our geography is that the potential to grow in 2020.

Thank you. Our next question comes on line of matter Marshall with Morgan Stanley . Please proceed.

Great. Thanks, guys.

He spoke about the 20% increase in quota carrying comps and I just wanted to kind of check it makes sure that kind of all positions that you were looking to hire for you know are filled at this point and then just increases in Opex right 2020, or just you know more commissions as they become productive and that I have a second question.

Yeah. Thanks to the question so.

Most of the positions have been filled our opex outlook certainly factors in both the built positions and those that we anticipate will be filled shortly and I'd. Just highlight the fact that we took the harder path here of cutting to invest.

We restructure we reduced layers, an increase span of control and simplified the organization, which freed up the capacity for us to go in to invest in frontline sellers and I think that has you know that was tough to do but it was the right thing to do so certainly you haven't you will not see a 20 per.

The increase in Opex for our sales organization, but it's great to see that we're going to have 20% more sellers that are actively positioning and selling a the technology in the differentiation that we believe we have especially in the enterprise but.

Got it and then just maybe on the CTO transition does you know.

Any kind of customer feedback or kind of as Raj starts, making the rounds of customers any kind of early commentary would be helpful. Thanks.

Yeah. Thanks for the question I think the the CTO transition has gone remarkably smoothly.

Because.

Did I had a very nice job in sort of seamlessly transition over to rise. There was in fact, a period of over of overlap between the two executives Raj is an outstanding technical leader that has experienced a in the cloud provider space, but also in the enterprise.

Well the Intel for a number of years, so had some experience in the silicon photonics space.

At Vmware a lot of experienced in enterprise software. So I think the the breadth of his experience has already in just a month or two that he has been onboard been a huge benefit to us and I think he's going to do a fantastic job leading the technical strategy in this company going forward.

Got it thanks.

Thank you. Our next question comes from light up Paul Silverstein with Cowen. Please proceed.

Got it for taking my question and I'll apologize because I'm going ask to revisit some questions from earlier first off can on on the margin questions you've been asked.

A couple of things one I thought that the review announced reduction in the last round of tariffs.

I thought that that would benefit you in your peers will that not be the case secondly, what is the rate of price erosion has that changed one where the other I assumed for your from your margin guidance it hasn't.

And third going back to Simon's question, when we think about the levers going forward. It sounds like mixes the number one lever if I looked at what should do back when before you had the whole MSP to actually impacting revenue.

You were doing 64 in 63 off several hundred million of higher revenue if it to get back to that level or do you get back to 62, plus is it primarily a function of better volumes that magnitude or is there something else and then I've got a straightforward question on all Rami on your your risk.

Fonts to the demand question if I may.

Yes, so with respect to tariffs first I would say that and we've been predicting tariffs would would impact our business by 30 to 50 basis points for the year and that's largely played out as we expected I would.

Remind you that's a total gross margin impact if you actually take the impact of product gross margin, it's greater than that as as the denominator gets smaller rice. If you look at product only gross margin. The tariff in fact is greater than 30 to 50 basis points as it relates to way for and the change there we did not see a benefit in time to impact Q4, we will we will slightly benefit from that.

In Q1, <unk>, you know the Q1 tariffs, but our biggest opportunities to continue to mitigate the entirety of of the tariff as we continue to look at retooling our supply chain thought something its ongoing I'll be weren't able to mitigate much in Q4 in fact, our Q4 tariff exposure was the highest of any of the quarters in 2019.

Which is it signed just not having enough time to really react to way for we are now reacting and we expect to be able to mitigate some tariff impact going forward.

As far as the big levers I would I would I would order them in volume is number one I mean, we did you know although we're pleased with our Q4 returned to growth. We are still seeing product revenue down that is obviously a negative to our gross margin our product gross margin in particular I was getting the volume back is would be number one.

Obviously, if we can mitigate terrorists further that would help and last but not least on a mix perspective as our software business continues to get stronger, particularly as we start to get more renewals and our subscription software business, we should see some lift in our software margin as well.

Thank you. Our next question comes from lineup, Brian in with Deutsche Bank. Please proceed.

Got it thanks for squeezing me in I also had kind of a question on 2020 outlook, mainly the levers for sort of top line growth I'm wondering in your view sort of what those are that can kind of caused revenue to perform better than expected and then any headwinds or speed bonds, we should kind of be aware of.

In 2020.

Maybe if you could talk about the cloud and enterprise vertical.

Thank you touched on service provider earlier, so that would be helpful. Thank you.

Yeah. Thanks, Brian Let me start and maybe Ken has something to add and it's best to think about it from the standpoint or verticals I think in the cloud space.

You know we saw good we closed the year strong in 2019, I wouldn't expect that Q4 performance this sort of sustainable on an ongoing basis based purely on the footprint that we have I think sort of mid.

Single digit mid to low single digit growth rates in the cloud provider space based on existing footprint is a reasonable assumption and the enterprise space I'd say continued momentum.

And if anything maybe even better strength in the second half the year as we get to more productivity with the increased number of sellers that we have that's out there not to mention the you know the continuously increasing strength of our joint portfolio. So, yes switching portfolio being managed by the Miss Clay.

Nickel versions of that have now entered the market, it's only going to get stronger and more competitive throughout the year. So I am quite optimistic about the enterprise vertical in a 2020 and I think that's going to be a good growth catalyst for us a NSP moderating declines right.

At a mid single digit declines in SP is probably in the right ballpark and it's based on a number of factors that have already highlighted.

Around the fact that SB need to invest eventually fiveg, becoming more of a catalyst to investments. The fact that we're broadening our solutions in our portfolio that we're selling the after you a into software switching and security. That's how we think about it I think that makes sense I think if you wanted to ask what could I what could go wrong I would.

Say clearly the enterprise business operating that dynamic macroenvironment, if that were to change materially or that could have an impact our ability to grow enterprise Rami already mentioned kind of service provider and club.

Thank you.

Last question will come from a line of pay house that capacity with <unk>. Please proceed. Thank.

Thank you have two questions you had no amex and pdx products out in the market recently I Wonder if you could update us on the uptake and refresh opportunities.

And then secondly, you've talked about switching strength into when opportunities in the cloud I Wonder if you could clarify whether if these were new wins that were coming through thank you.

Yeah, so as far as the routing products MX and P.T.I. I think we've now seen a few quarters. The P. T X momentum driven largely by the clouds vertical.

And I'm quite optimistic that that can continue the MX, we introduced new MX Fiveg line cards, roughly in first half of last year timeframe.

Those typically takes six months to nine months of certification that has happened now over the last couple of quarters and I think that starts to.

Also in some.

Some growth opportunities for us into 2020, and as I think the second question that was around switching and the cloud provider space and whether there were net new logos and the answer is yes, and the tier two space I think we've we've seen momentum as a result of both satisfying the growth did.

And tier two cloud, especially tier two cloud providers that have made a strategic decision to either stick with or to insource their data center infrastructure.

But also net new logos worldwide that I think will or help us throughout this year.

Thank you that is all the time, we have a lot. It for question and answer session allow me to hand, the floor back over to definitely for closing remarks.

Before we conclude the call I do want to make you aware, we will be hosting a tech talk on or secure SD Wan strategy on Thursday February 13th will also be attending the Goldman Sachs and Morgan Stanley Technology Conference is this quarter. Thank you for your questions and we look forward to meeting dignity through the quarter.

Thank you. This concludes today's conference you may disconnect your lines at this time and thank you for your participation.

Mm.