Q4 2019 Earnings Call
Ladies and gentlemen, thank you for standing by welcome to the afforded fourth quarter 2019 earnings announcement at this time all participant lines are in listen only mode.
The speakers presentation, there will be a question and answer session to ask the question. During the session you would need to press Star then one or your telephone please be.
Buys that today's conference is being recorded if you acquire any further assistance. Please press Star then zero I would now like the hand the conference over to your Speaker today Peter Salkowski. Please go ahead.
Because they're a good afternoon, everyone. This is Peter Salkowski, Vice President Investor Relations at four to not I'm pleased to welcome everyone to our call to discuss.
And its financial results for the fourth quarter and full year 2019 speakers on todays call, our Kinsey Fortinets founder Chairman and CEO and Keith Johnson, our Chief Financial Officer.
I'd call that will be available for replay via webcast on our Investor Relations website.
Can we get our call today by providing a high level.
Perspective on our business Keith will then review, our financial and operating results, providing or guidance for the first quarter and full year of 2020.
Before opening the call for questions during the Q any such that we ask that you. Please keep your questions breed for limit yourself to one question and one follow up question to allow others to participate.
Before we get I'd like to remind everyone that.
On today's call will be making forward looking statements and these forward looking statements are subject to risks and uncertainties, which could cause actual results could differ materially from those projected.
Please refer to our SEC filings in particular, the risk factors and our most form 10-K and form 10-Q for more information.
All forward looking statements reflect our.
The only as of the data this presentation that we undertake no obligation and specifically disclaim any obligation to update forward looking statements.
Also all references to financial metrics that we make on todays call our non-GAAP unless stated otherwise our GAAP results and gap. The GAAP. Non reconciliation is located in earnings pressure with I don't know.
Presentation that accompanies today's remarks, both of which are posted on our Investor Relations website.
Lastly, all references to grow or on a year over year basis, unless noted otherwise I will now turn the call over it again.
He goes and a sentence I'm one for drilling to this call would be all fourth quarter for you had plenty lumpy resolved.
We're pleased with a bar strong fourth quarter performance.
This includes 24% <unk> 800 to limit.
By solid execution on the gross across each of our Mark.
Uh huh.
Equals, 21% 614 million, which portal revenue up.
19% and assumes revenue up 23%.
Oh look up off of your margin was 27%.
Well 20, lunching, Google increased 21% two points Experian Romil was up 20% of $2.2 billion nominal cap off your marginal was 25%.
It's lobbies out what Cleveland.
40 gig technology with S.P., you see QST.
Oh, you liquid security fabric platform and the hybrid multi cloud offerings.
40 that was recently named one off the top sweet lender in the 20 been Tim Conder Magic.
During the full one age infrastructure.
14, a secure proven networking approached where I see what I'm all for customers to most comprehensive solution, we see acuity and put us quite a lot more can could be PTT neglect no single box.
Unique approach that's a long also pool.
Simply because maki sure over the past 12 months.
More than one new was sold in companies you see 40 minutes to Q I just want solution on the 70% of a top tier supervisor offer all I see one solution, we are not lead in size vendors.
Hey, we announced a release afford to pay for do you have the most affordable next generation firewall, we secure I see when.
The 40 that include on <unk> I see what do you foresee acuity processor.
Well go deeper security computer, reaching Alpha Sweet corn is required foster the industry.
I'll close which use generics generics gpus.
The traditional prime interface that with security expanding across the Unpartnered infrastructure.
Well the white here that I won't ask.
I see one five Gee I missed what a nuclear network, including the wife.
Hi on internal segmentation.
So I barely people also secured through the networking high performance results.
Oh, Gee clearly competitive advantages.
Going forward the walking the talk last year for them at the same close engine.
Helped us grow faster than our competition and at the market overall.
First we continue to gain market share network security given by all asking your competitive advantage.
Oh, Hi, skewed Nokia people asked qualities of interest to communicate a medical functionality, including I.
Sure Dan why momentum is strong.
Hi, Matt what quality continues to increase.
The introduction of among some guys opinion I something for 97.
Well I suppose wouldn't get caught up with them to seven no later this month.
Why then all competitive advantage.
The second pools engine in self secure the fabric platform.
Quoted hybrid multi cloud deployment.
Mike patented platform, obviously competitor loosely <unk> late quarter solution.
Yes, it could have fabric each.
On the Barbican, what's most the lined up.
Oh water alternating Tobey Maguire security platform.
And the protection.
Making it easier for CROSSMARK consolidate <unk> security vendors.
Sure well continue to focus the.
Sure.
We should strongly positioned unfortunate lung gross.
Thank you back on page.
Hmm.
Logic open compute while competition.
I don't see Hometeam Fiveg hybrid cloud on page solution.
Transfusion put the latest generation of cyber security.
I Wonder said before he had to him all partners with the gold copper walk I know customer for their support.
No I have a ton of coal, but to be won't close until the fourth quarter of well performance and to provide guidance.
So plenty plenty.
Thank you Ken.
Let me first note that except for revenue financial amounts our non-GAAP growth rates are based on comparisons to the fourth quarter and full year 2018, unless stated otherwise.
The slide references I make refer to the presentation posted on our Investor Relations website.
I'd now like to provide a summary of our strong fourth quarter performance the follow up on certain metrics from the analyst day.
We believe the metrics, we shared last November I, let our diversity by geography customer size industry segments and solutions as well provide insights into our financial model.
Let's turn our fourth quarter.
View with revenue.
Total revenue.
$614 million was up 21%.
Revenue growth was led by the fabric and cloud segments with over 30% growth followed by network security growth at 18%.
Product revenue growth, it was 19% or 239 million.
Then if any from both legacy firewall use cases, and consistent with Ken's ft ran commentary from continued adoption of our Fortigate based secure SQM solution.
Simply put our secure SP ran firewall use case combines in a single appliance security with application the application aware routing.
They can lower npls and other costs.
The fourth quarter revenue growth of 19% was consistent with our strong third quarter performance.
Even when faced with a more difficult year over year comparison.
We believe our product revenue growth, maybe among the highest and this network security industry.
Moving to service revenue.
Our higher margin service revenue increased 23% to 376 million and represented 61% of total revenue.
Increasing pinpoints in four years.
Fortiguard security subscription revenue increased 24% to 205 million.
Forticare technical support and other service revenue increased 21% to 170 million.
Renewal rates remained consistent with prior periods and within the guidelines we provided at the analyst day.
Deferred revenue at the beginning of the fourth quarter accounted for approximately 90% of service revenue.
Revenue growth on a geographic basis saw the Americas up 23%.
Pack up 22% Adhamiya up 19%.
Before continuing with our fourth quarter results I'd like to highlight our revenue performance for the year.
Total revenue for the full year grew 20% to two point.
$2 billion.
Product revenue grew 17% service revenue grew 21%.
And represented 63% of total revenue.
Returning to the fourth quarter with a focus on billings.
Total billings increased 24% to 802 million.
Network security.
Got it can service billings increased 20% and accounted for 73% of total billings.
Illustrating the continued traction with our fabric platforming cloud strategies.
Non network security billings increased 35%.
In Europe, we saw Germany performed better than planned well in the UK.
Billings declined.
UK decline appears likely to Brexit distractions, and we expect UK billings growth will return to positive territory in the current quarter.
Looking at vertical billings by vertical service providers that MSS peas accounted for 18% of total billings.
And we experienced.
Outpaced growth from government financial services retail and education.
As a follow up to the analyst day.
But not the top five verticals again accounted for 65% of total billings.
At year end total deferred revenue increased 27% to 2.1 billion the short term deferred revenue increase.
22% to 1.2 billion.
Looking now at deal sizes.
And illustrating our continued expansion of the enterprise market.
Deals over $1 million increased 36% to 64 deals.
Secure SD Lan was a leading contributor to the increase in the number of deals in excess of 1 million.
There's accounting for 10 deals in the quarter up from four deals last year.
And with a reference to our diversification we have now completed 11 quarters in a row without a single transaction representing over 2% of quarterly billings.
The number of deals over $250000 increased 29% to 400.
Hundred 69.
And the number of deals over 500, K increased 53% to 197.
In the fourth quarter average contract term increased one month to 26 month.
As we noted at the analyst day secure SD Lan transactions include a greater mix of enterprise customers and somewhat.
Longer contract terms.
Moving back to the income statement.
In the fourth quarter.
Gross margin improved 230 basis point.
78%.
Product gross margin improved 400 basis points to 61.9%.
As you saw the.
Third quarter product gross margin benefited from gains in average selling price.
As well as lower direct unit cost and indirect cost.
We're pleased with the product gross margin improvement we've achieved in each of the last two quarters.
Services gross margin decreased 90 basis points defeat the 8.2%.
Operating margin for the fourth quarter increased 110 basis points to 26.8%.
The improvement in gross margin was partially offset by an increase in the pace of hiring mostly in sales and marketing.
Lower sales attrition and spending associated with recent M&A activity.
For the full year gross margin.
77.5%.
Hub 150 basis points from 2018.
[noise] benefiting from a 190 basis point improvement and product gross margin.
And for the full year, the operating margin was 24.5%.
220 basis points from 2018.
Total headcount ended the year at 7082.
An increase of 21% from the end of 2018.
Oh, the two fourth quarter acquisitions increased headcount by 135.
Excluding these two acquisitions head count would have increased 19%.
Given the strong operating.
Income performance net income for the fourth quarter was $132 million or 76 cents per diluted share.
Net income for the full year was $432 million an increase of 35%.
Resulting in earnings per diluted share the $2.47.
On a GAAP basis.
Reported full year net income of $327 million, one dollar and 87 cents per diluted share.
This represents our 11th consecutive year of GAAP profitability a.
A milestone we've been able to achieve every year since becoming a publicly traded company in 2009.
Moving to the same into cash flow summarized on slides 10, 11 and 12.
Adjusted free cash flow for 2019 increased 28%.
To 776 million.
Capital expenditures for the fourth quarter $247 million, including $36 million on real estate spending.
For 2020 capital expenditures are expected to be between $210 million to $240 million, which includes spending on the campus expansion.
We expect first quarter total capital expenditures to between 20 $535 million again, including spending on the campus expense extent.
Campus expansion.
In the fourth quarter, we repurchased approximately 303000 shares of our common stock for a total costs of $23 million.
For the full year, we repurchased 1.9 million shares for a total cost of 141 million.
Have you know the fourth quarter the remaining.
Our repurchase authorization was 1.6 billion with a plan set to expire at the end of February 2021.
Before wrapping up a guidance I would like to offer information on two additional areas.
Or for sure our fourth quarter acquisitions and also ft win.
First on the M&A side.
We completed two technology and talent tuck in acquisitions in late October in December.
With a combined contribution to fourth quarter revenue a significantly less than 1%.
These acquisitions pulled down fourth quarter operating margin by approximately one half a percentage point.
We expect the impact from these acquisitions.
First quarter and full year 2020 operating margins to be roughly a 100 basis point headwind.
Second our secure FC when offering continues to be appointed differentiation reporting that.
In the fourth quarter secure ft. When buildings represented high single.
Digits of total billings.
In 2019 for the full year secure ft. When added about 7.2 product revenue growth.
And represented mid to high single digits for total billings.
[noise] the full year basis, there were no significant.
And changes to the year to date third quarter metrics for security when that we provided.
Analyst day.
Service contracts continue to attached to the Fortigate at a rate consistent with other fortigate use cases.
And finally, new logos.
We continue to account for approximately 50% of secure ft ran billings.
Next I'd like to review our outlook for the first quarter and full year 2020 summarized on slide 13.
Which is subject to the disclaimer regarding forward looking information that Peter provided at the beginning of the call.
For the first quarter, we expect billings in the range of 635 to 655 million.
Revenue in the range of 555 million to 565 million.
Non-GAAP gross margin of 77.5% to 78.5%.
Non-GAAP operating margin of 19% to 20%.
Non-GAAP earnings per share a 50 to 52 cents, which assumes.
The share count of between 175 from 177 million.
We expected non-GAAP tax rate of 24%.
As I begin to provide 2020 guidance I'd like to remind everyone of the financial model expectations for the next three years that was provided at the November analyst day.
For the period.
2020 through the end of 2022.
We expect organic billings and revenue growth to be at least.
15% for each of the next three years.
And non-GAAP operating margin to average at least 25% during this three year period.
[noise] for 2020, we expect billings in the range of 3.025 billion to 3.075 billion.
Revenue in the range of 2.525 billion to 2.555 billion.
Total service revenue the range of 1 billion.
635 million to 1.655 billion.
Non-GAAP gross margin of 77.5% to 78.5%.
Non-GAAP operating margin of 23.5% to 24.5%.
While we estimate the recent acquisitions will be a 100 basis points year to year.
When to our 2020 operating margin included in the numbers above.
We believe our operating margin over the next three years will average at least 25%.
Non-GAAP earnings per share the $2.70 to $2.73.
Which assumes the share count of between 181 or the 2 million.
We expect our.
Non-GAAP tax rate to be 24%.
We expect cash taxes to be approximately $40 million.
Along with Ken I'd like to walk on the site response and again the in silo teams to Fortinet I think our partners our customers and the fortunate team for all their support and hard work with that I had a call back over to Peter.
Thank you very much case, operator, we're ready to open up for you and isolated.
Thank you as a reminder to ask a question you would need to press Star then one on your telephone to withdraw your question. Please press the pound key.
Our first question comes from the line of Brian Essex with Goldman Sachs. Your line is now open.
Hi, Good afternoon. Thank you for taking the question and congratulations on some nice results.
I was wondering.
You know Keith maybe you could unpack the guidance a little bit.
You know coming in particularly on the growth side of the equation several hundred basis points over a year or kind of at least 50 per.
<unk>, 15%.
You know guide on the analyst day, where does the confidence there come from and what are some of the levers.
That could.
I guess give us some comfort that theres, they're appropriate level of conservatism in that number.
Yeah, I think the when you look at.
Our longer term model, you're probably looking more at Gardner growth rates in terms of what you expect to see from SD Lan would you expect to see the network firewall and.
And what you see to see that would you expect to see in the fabric and I think the guidance certainly within those ranges when you factor in our historical ability to.
Outgrow the market I think as you get if you pull that in particularly to say.
The first quarter in the current year is much more based upon the the pipeline and when we look at the pipeline and the opportunities that we see the in the pipeline. We clearly supports the guidance that we've just provided.
So we can increase sales capacity.
I just had high amount of South American.
Yes that region.
Cost of 20%.
Hi, called the increase what that might help and travel to additional costs.
Got it that's helpful and maybe if I could fall for the quick one on on a current results for the quarter.
Product revenue you know nicely strong in the high teens and services revenue as well during a quarter, where maybe some of your peers sounded a little.
Our challenging to put up positive product revenue growth.
At the very least.
You know how much did.
I guess SD Lan in fabric contribute to.
Each of those segments and how might you view the overall spending environment for core firewall considering the results. So you had an.
Yeah I did hear you you comment on high single digit SD Lan contribution, but if maybe playing a bigger picture of.
Other contributing factors to those to those line items in the and the spending environment overall will be really helpful.
Yeah. This guidance what anomalistic surety, we believe we are cubic any a lot of mafia sure because the par dock.
Architecture resell PC, probably quite a few is a has huge computing power can keep adding whether security function and all that that will consumption of FSP when.
Even the part that we announced today like that's from three acts replenishment acts more powerful then than other competitors Thats your average.
So this will make us keeping gaining market share and also I see when market last year was about 1.5 billion may grow 15% year over year in the next few years, so we're not as eating lender.
As the most cost more I know some also service provider also starting about buys Qs solutions and we do PD.
Also keep in Kenya sure.
Space. So that's also will help us and data fabric can see almost bobbo.
Now with security growth because that I'll fabric, it's mostly internal people up and while integrated.
It's more easy to lag upsell cross sell by US some productivity and then because all the other part of fabric.
What can competitive quite well so thats one customer see the benefit of Alpha consolidations. We see that's also a gross flat there's some other newer technology. We also pioneer.
And.
That's probably more long term maybe few.
Few more yet to see move onto your line is probably do speed. He will be the also meetings I want to technology.
Did you change in this space.
Fantastic. Thank you very much.
Thank you.
Thank you. Our next question comes from the line of Brad Zelnick with Credit Suisse. Your line is now open.
Fantastic and I'll Echo my congratulations what a real.
Finish to 2019 and impressive guidance as well.
Ken if I can ask you a question.
As I look to competing SD Lan solutions out in the market I think there were some out there that take a different architectural approach in delivering it mainly as a cloud service aside from customer.
Can you maybe speak to the architectural trade off of centering the the functionality in the cloud versus delivering it as you do.
I think.
Mhm foam applications will be called actually helping like.
Multi point, many nice you won and.
And the same time.
Then zima CLO, yes.
Yes, a just a few research actually whether phone the common as say all come from ACA academic CMU. This to the cloud actually increased security risk.
And that's what you've been busy in the cloud you also need to secure to call. It.
Self so that's also helping like that we'd be called hyper scale. Some some august approach to cat inside that works and that.
And.
So thats probably beyond the traditional I mean, one SD Wan side.
So that's where we kind of working with a lot of service provider call provider.
And mccaskey, one part of that whole to offering and then we also understand sometime they haven't been as model, we must supporting you Chaucer He's had a more competing with each other so.
So that's kind of that ecosystem, starting working quite well flaws.
Thank you that's very helpful, Ken and and Keith if I could just follow up with a quick one for you.
Yes, those seem to be running a little bit hot can you comment at all and linearity I mean at the same time, you've obviously got guided to a very nice Q1 and full year next year.
But any color on on the jump would be helpful. Thank you.
Yeah I think.
The math the DSO you probably.
Picked up about a day from the acquisitions.
That pretty much puts us back in line with what you would expect normally.
I would offer my experience and high Tech on the Christmas holiday season is always very busy.
Okay supporting this unusual.
Fair enough. Thank you so much HM thanks, Rob.
Thank you our next question comes.
From the line of Melissa Frankie with Morgan Stanley. Your line is now open.
Thank you for taking my questions and congrats on a solid quarter I'm, Ken <unk>. It looks like you're seeing good growth in large deals and multimillion dollar deals and I know that you said that S. C ran is a leading contributor to that to strength, there, but I'm just wondering.
If he could provide more color and what those deals look like is it your existing customers that are refreshing that the branch or are you are displacing some competitor solutions that are coming and you're coming in because of the asking when capability.
For half the ice do you mind, Kosmos a new customer, especially come.
On the price.
That's also libel asked to cutting into the traditional and the price network security space, All you've engine Parnell occupancy.
Traditional are probably took base that will security now need to be expand the wind side I'd ask you about fiveg and also to the internal lack though whether.
Internal segmentation switching quality internal Wi Fi.
So that's where we see that probably internal even bigger market compared to the today when that a mine site.
So we'd see a huge opportunity, especially.
Introduced to the new MP seven or so the first part on average and.
The seven which is about five times faster than the previous chip MP six I will help us cat inside of that walk you know more high speed environment within the cloud. So that's also looked like I. Just you know gross so I do see.
So nice you go to one side and also quarterly internal now with side how pause expand.
Lot of a new market insight on the price and also given a lot on new customer for us.
Okay very helpful. And then I have a follow up for Keith Keith You mentioned that S. P is we're increasing in your commentary on gross margins can you just maybe comment on what's driving that ASP increases that.
Just a mix shift dynamic or did you actually raise prices on appliances.
Yes, I think the yes, I think what I'm trying to do as parse out the fact that in the benefit to gross margin. There was with repeat is to an indirect which I would attribute to economies of scale that we're seeing we have a large warehouse facility, we acquired several years ago that.
And I think that's.
So fairly quote unquote permanent benefit on the indirect side.
The direct side.
I think the operations team does a very good job of each quarter working down the average direct unit cost and then the third component was ASP and I kind of broaden that conversation. If you are talking point.
From the last quarter I attributed to discounting and the reason.
That is I would put discounting as a component of ASP, but I also want to give some credit to.
The ability to the company people to maintain no the somewhat normal priceless changes you have from time to time and not giving up those back getting back given those back and discounting.
The other economies of scale.
Wilkins rally the Hesik chair side, so weird a number one unit shipment probably more than another point that must be number for combined as well it helps us.
By the kind of a lower to average cost alpha off for a six year, which gave us Hughes computing power over to.
Generic CPQ a combined are you seeing so.
That's also helping drive into cost lower.
Very helpful. Thank you.
Thank you. Our next question comes from the line of Shaul Eyal with Oppenheimer. Your line is now open.
Thank you good often on gentlemen, congrats on the spot.
He works and.
No, Germany, and the UK or maybe we should quoting Frankfurt and that London.
We'll have two countries kind of then I'll talk talk a little bit about whatever the.
Right the strength in Germany on it and why do you expect.
The key terms back in in the first quarter.
Yeah, I think the sorry Academy to jump when you [laughter] I think is in Germany, I think assistant it's been a balanced growth throughout the throughout the quarter I think we came into the quarter would perhaps some concerns given the economy, there in Germany, but the diversification.
We see within the country I think paid off for US I think in the UK to answer the question very specifically when I look at the pipeline in Q1 versus what we saw in Q4 I feel very comfortable the comment about it returning to positive growth in the quarter.
Fair enough fair enough, maybe elaborate current wrong I'm bouncing back what's what's driving.
I think that.
Do you see that.
Contribution or growth is sustainable within that region.
Yes, he probably has a pretty good fourth quarter and also we stuck in speed up some higher him here, which is that they'd be happening early last year.
Also kind of helping drive to future growth.
Well done thank you.
Thank you.
Thank you. Our next question comes from the line up with team Uh Huh.
Fulani would you be yes. Your line is now open.
Hi, good afternoon. Thank you for taking the questions.
Ken I'll start with you just with regards to ask you win a tremendous momentum there I wanted to understand just from a strategy perspective, how you are pitching the SQN value proposition to your telco and service provider at carrier partners.
It has to some extent the security when.
Mission is that counter or Q and that the other areas of telcos businesses like the npls streams. So I wanted to better understand what your strategy is with with telcos and then I have a follow up for Keith If I may.
Yes, it's.
No more total costs ownership, especially we have a one box.
<unk> compared to some other.
I'll turn that war vendor or whatever they need to have a twist. We boss wealth last few wired wireless acuity level now will cancel we have already seems likely to single box and also because the huge computing power home from all SP you secretive process units.
So we can easily.
I'll pull form on add additional function combine all the secured an hour function together.
Do you like easily like a suite who.
30 times faster than onto your like a single SQL function pop health excluding box.
So thats the I'd advantage, we have in a in the technology last month.
Basic chip gave us huge computing power not just for the SQM function, but also additional security functions dish on that will function and if we we keep adding there.
But elsewhere to service provider enterprise huge benefit because for them. They kind of what are you seeing the box.
Touching the weather service space.
Oh come down about health and lower enterprise total cost.
So that's where we may see over 70% top tier service provider ill offer I see less solution, so thats, where we become the leading vendor.
We'd beat if we had the most of customer base, Saudi Adolfo Sq platinum is a 20 watt solid customer.
Companies try to use you know I see one which combined I see where security to gradually and also as Martin interesting.
I would assume we offer.
That's the way actually is the highest level surveys we have so we have like a are you Kim said based on the question of waste and then that we called a sweet.
These surveys which.
Unlike including all the U.P.M. enterprise and passed all the professional service equal to ask you improves your name and the management service.
But that's where so I see when definite helping drive the additional service that is from security into into another new enterprise customer reach we comp.
Hi, guys people on dealings comp on a new customer we should never bought all other part out before.
And I think just follow up on Kens comment.
Yes about the 70.
70% of DST, when sort of provide us I think we probably saw particularly the first half of 29 team was.
A little bit of hesitation from.
The carrier in the service providers, and maybe I alluded to there mpls revenue stream.
But we've certainly seen a shift in that thinking I would say over the last three or four months.
That's super helpful and teach just for you or your very specific about the step up in sales hiring answer the higher pace. The sales hiring I'm wondering if you can put a.
Finer point on where these additional sales resources and increased sales capacity is going to be concentrated whether from the vertical or geographical or even use case perspective I'd appreciate that color. Thank you.
Yeah, I think the way I, probably respond to that question is the way we look at it in terms of adding sales capacity and there's probably two key criteria that kinda.
Talk about one is we want to see somebody who sales leader who has demonstrated performance I mean, you've given more resources that they're going to be able to execute whether it into that they want that initial responsibility.
Now like Luckily when a very good position with that that crosses geographic life and across as vertical, but I think thats more the playbook that were after right now.
Thank you.
Thank you. Our next question comes from the line of Sterling Auty with JP Morgan Your line is not open.
Yes, Thanks, Hi, guys can wanted to start out with.
As we think about yes, the wed product road map, especially here in 2021.
Some of the key elements that you would expect to.
Produced this year that had been missing in the in the solution thus far.
I mean definitely more working closely with a service provider, which we kind of almost dominated by space and.
All for lot of a match I see less service.
And also a lot of a channel Panasonic mobile can business high, especially assessing and agreed or decreasing global seeking them either so they see the benefit alpha.
SQM solution compared to their traditional.
Turning to solution or the other seem to be.
Probably maybe overtones I'll, maybe we'd be ahead right now I study.
The M. Pesa haven't we had we kinda talk about in on a state and then later this month, we introduced the first part are beautiful MPS seven I you know a salary bus at all now.
Which also what changed a.
Landscape this more like a part of studying go inside of that walk. So that's where does the internal segmentation to hyperscale. Some moderate pod could be even people market then the Whitey and network, which is actually when we were beating the last few years. So that's where there's a few glad we're keeping helping us back at that I assume some.
And will help us mortgage.
Do you plan on one side is that's Douglas season, not on chip.
Seven will help you sound a nuclear not walk in in a high speed that environment. So that's where are we starting see that additional param, we'd have based on that will security needs, we expand into the one side and also talking about inside.
Got it and then Keith I apologize I was proud to between calls but.
I apologize if you covered it but I want to better understand the operating margin guidance here for 20, Twond and in particular, how much of that impact is coming from being silo acquisition versus the increase hiring and.
Typically no are you at the end of this maybe increased investment phase and how does that margin outlook for 2020 fit within your longer term margin guide.
Yes, I think very good questions that we tried to cover off in the prepared remarks that a reminder, including the fact.
Back to their comment before was that from 2020 through 2022, we expect to average at least 25% operating margin during that three year period of time in that first and foremost that has not changed.
The other data point to keep in mind, even in the commentary was that the M&A is the kind of hit in the tail.
Half of the fourth quarter, the drag an operating margin in the fourth quarter was about a half of a basis point.
And the drag for the next year, when we have full quarter operations.
It's going to be about a one point of drag and so one way of looking at it is taking our operating margins the midpoint and then adding that point back into it.
[noise].
Got it thank you.
Thank you. Our next question comes from the line of Walter Pritchard with Citi. Your line is now open.
Thanks, a question on the on the subscription side and specifically pretty good performance on the on the sport Guard. There can you help us understand.
Going into that as you've seen that that business accelerate this year, what's been the driver of Ah if that trend.
Yes for to guard.
To go back to some commentary from the analyst day, 40 guarded about 85% afford to garner a bundle security bundles.
You can add to that some.
And security services. If you will see you also going to get a when you're trying to model that you can also get a lag effect of when you see hi product sales say higher in 2018 than they were in 2017, those higher product sales in 2018, you're going to test service contract, which become revenue in 2019, so you're going to get the lift in 19.
On the increase in product you product sales in 2000 than 18.
Got it just quick one on a on acquired revenue how should we think about any contribution from you said small contribution in Q4 any contribution from the two acquisitions in the 2020 number.
Yeah, we just rolled into the total and I think the comment I gave was it.
As far less the 1% in the fourth fourth quarter I don't really see that changing for the balance of that I have visibility to in 2020.
Okay. Thank you.
Thank you. Our next question comes from the line of Jonathan Ho with William Blair. Your line is now open.
Congratulations.
On the strong quarter, just one for me I just wanted to get your sense of what's happening in the cloud opportunity you guys mentioned hybrid cloud and sort of the multi cloud security opportunity just wanted to get a sense for what trends you're seeing particularly for 2020. Thank you.
Oh, Yeah, we do see how that's a pod.
Oh fabry offering so we keep the cost more flexibility what are the ones you put on prime recycle to cloud all chosen T phone call provider, we should they offer we offer the same a.
Seemed like a user interface the same software hardware.
Kind of a.
Solution for them and.
And.
Also we will keep is a call provida service provider, while and a and try to expanding about here, that's what that's whopping Australian for us.
We do believe boasts Clifton age I need to be working together southern since goodwill class. So thats good for the age so that's where I.
I have the whole host.
Lucia instead of a on a folks have won solutions was asked will be P.B. eckel, what are the fabric on the cloud the age I do I mentioned Anika ionkey old he and the Fiveg at all to be.
Kind of working together to make it more secure.
[noise].
Operator next question please.
Thank you. Our next question comes from the line of Michael Turits with Raymond James Your line is now open.
Hey, guys, good afternoon, and even great quarter I'm on the first Rick for Ken Hi.
That's the Fortinet security when Equinix, so as to when he said it as a full service.
What's your.
What are your offerings and what is your strategy on on a full cloud based security offering.
Think of it would be analogous to the scalar offering either for local breakout and or for.
Sure I Trust that were Texas.
He's scan or don't have that I see one.
And.
Sometimes it also partner to better.
And on the other side like a lot of a service provider like back when I saw some under the they do have a.
Quite abroad.
Customer base enterprise customer service provider and the leverage their infrastructure, So SD Wan definitely.
As a new technology solution Ken Ken.
He improving the surveys note a cost.
And that's where both service provider to under press customer all like that solution. So that's where we kind of approach from Bose.
Last fun and customer angle and resolve marketing for.
These all BTI resource and the other one comp on the service provider pontiff is them to talking about their customer to improving to.
Service, Tony total lower.
Total cost of ownership, so thats, where we see a will come with service providers, a one off the rocky important ecosystem for us.
And then for key thought on cash flow this year.
Cash flow grew less than net income this year in the Twentys versus third is how should we think about it going into next year. That's just timing that reverses should we should we think about cash from ops growing in line with net income or even next year.
But if you're looking for cash flow from operations the near excluding the the real estate correct, you're not talking about free cash flow, Michael not talking about free cash flow just cash out yeah. There's I don't think theres nothing different in terms of modeling it other than just maybe on the quarter ended how payables got paid and obviously when got collected so your premise that basically but.
To put word of mouth don't look at any one quarter, but look out over time you're right.
Right. So in other words in line with net income or EBIT growth you actually was good guide Yep Yep, Okay, great. Thanks very much.
Thank you. Our next question comes from the line of Rob Owens with Piper Sandler Your line is now open.
Great.
Thanks for taking my question wanted to drill down a little bit into linear already with regard to 2020 and I know in 2018, we saw very strong back half are you guys and obviously some of the do the new products FC when help there, but you're also making that push up relative to enterprise. So are we seeing the business become a little bit more enterprise backend weighted does that play out.
2020, and what should you are our initial linearity cosby. Thanks.
Good question, we spent some time without actually recently looking at an epic.
I think it to start looking at 2018 is when the equity by quarter, that's probably a pretty good idea of what we think to that part of 2018 linearity. We that's a pretty good idea of what 2020.
Look like this in terms of how we're modeling internally so you're probably looking.
Book, ending the year with starting off at a say a 21%.
And ending the year in the fourth quarter with maybe 20, 930% kind of us of a model any between you know where a model where Q2 in Q3 or tend to be very close together. So.
We're probably at around a 20, 425% number for both of those.
Yeah, we also improve we the hiring.
Second half of our 2019.
Which.
Hi won't be contribute into the 2020 girls, so that's where.
That said are hardly anything like a fuel switching fuel.
Definitely what well see some tell starting from pop contributing they see a 2020.
Great and then if we look at the large deal metrics, particularly the largest of deals are these you guys pushing up market into data center situations that are massive or more branch network type situations could you unpack that a little bit for me. Thanks.
It's more on the price.
No because a lot of I'm afraid I see that benefit off a merger I see when all I'll be coty infrastructure security involving more port in fabry causes for the Fabry also helping to make that even Andrea.
So that's where most alstom O'connor.
Well to sell multiple product back and also dicey.
I think title Monaca designed to price so there's definitely helping increase 15 size.
Great. Thank you.
Okay.
Our next question comes on line of Andrew Nowinski with.
D.A. Davidson your line is now open.
Great. Thank you and congrats on a great quarter. So I I also wanted to ask a question on your large deal growth you know we saw deals greater than 500000, incrementals greater than a million with impressive growth again this quarter yet your high end appliance revenue.
Leg small and mid range of planes growth. So I was just wondering.
Is if you could just provide any more color as to what you know wire.
Why our customers are spending more upfront with you since it doesn't look like they're buying simply just buying larger appliances.
The new point, Asacol mean, [laughter] like I said it is pick us almost four five years would be one of them be seven or so.
That's where we finally released and the first part I will come in later this month.
So that's a well have a huge advantage compared to and Ah. Okay. So the someone else part.
So that's where a that not not will help yeah induces Keith good follow question Robin to expand on the on.
His comment I think when you look at where the large deals are coming from.
I would probably say there's really three sources for those when is the way I know you talked about.
He was a large distributed enterprise that you're referring to and then the third is yes, having success inside the datacenter and displacing incumbents and I think each of those are contributing to the growth that we're seeing a million dollars deals.
Great. Thank you and then as just a clarification regarding your gross margin I know you mentioned, a as you know the economies of scale.
Contributing to that but the guidance for 2020 is a significant expansion from 2018, I thought that new appliances typically carry a lower gross margin at least initially.
And so given the new appliances, you've talked about that come out later. This month I was wondering if you could provide any more color as to what might be.
Driving your gross margin higher in 2020, and offsetting that perhaps initial headwinds you normally phase with the new appliance.
Yes, it keep in mind, we probably have 70 or 80 different firewalls.
Priceless.
Anyone models at one point in time.
And then also add to that that wouldn't be introducing a new product doesn't necessarily mean, that's going to have a significant revenue impact to give a point or to a different quarter.
So I think we'll I, what I would overplay that new products, we are having an impact on gross.
Unless we're doing a lot of them all at once and they're coming online.
I think the if you go back it was actually in the.
Did you say you're talking about product gross margin and I think you were in your commentary I made reference to three components. One is I think the indirect benefit is here to stay given the economies of scale I do believe that the direct benefited can made reference to over.
Basic advantage will continue to manifest itself into our into our pricing and into our billings and then thirdly I now have two quarters in a row, where what do you want to call that ASP increases or holding line or discounting I'm not going to commit to say that that's going to be forever, but I think those are the components that were looking at in terms remodeling of gross product gross margin going.
Forward.
Lastly, fielding a total gross margin, it's really a mix shift as well, whereas at the moment, we're probably modeling a little more services with higher margins than we are with products at this point in time.
Also please.
Two new I suppose you measure to seize I suppose you foresee some chip where do you for a flawed.
Seven we have a huge.
Good empower hansman, Tom a 40, K., which also enable hospital keeping adding all the new function, which can also drive the service.
How can like.
Mike.
Hi, guys nice these comments he additional shoot will value.
And if it's the same cost.
So that's also will help improve our margin.
That's great. Thanks for the color.
Thank you. Our next question comes from the line of Dan Ives with Wedbush Securities. Your line open.
Yes. Thanks.
So my question specifically on the.
Government vertical I mean could use maybe talk about what's going on there. Obviously is a lot a lot of transformation going on in deals across especially on the federal side, where you guys. Obviously play well. So maybe just talk about that in terms.
The composition of deals activity and just as anything changing on.
Federal.
Yeah.
That's a really my you know I saw something this morning on ourselves people talking about very exciting times are coming in the U.S. fed.
But I think really what you're seeing in our model right now is really the diversity in our federal business, partly in our government business, which includes some benefit from the U.S. said, but also state local and international governments.
Got it and Ken could use just hit on Todd you I mean, I know you you talked about before but just how you're viewing that over the next 12 to 18 months and were fortunate please in that opportunity. Thanks.
Oh.
Oh Fiveg.
[laughter] you need to be early.
Certain vertical maybe Uh huh.
Sumer, but is a.
Working closely with the service provider, but I see is.
Probably skewed need to couple of years out I can see material materially impact.
Thanks.
Thank you.
Thank you.
Next question comes from the line of Patrick Coalville with Arete Research. Your line is not open.
Thank you for taking my question and congrats and 60 impressive quota and the next is outlook I'm kind of scary.
When I asked a question on the free cash flow to start with how much you spending on in 2020 for the new campus.
Yeah, the real estate spending will probably want to between 100 1500 $60 million all in next year.
Got it okay very clear and then can I ask you about run somewhere.
I do a lot of.
Speaking to see Isos, and Ceos and in my conversation, that's probably the number one threaten the facing right now so I'd love to understand from 40 minutes perspective.
So how a tool.
Maybe driving conversations with you guys new customers.
Oh.
That's very important.
Topic, because the majority of attack today now come from inside so that's working Carnival security internal segmentation and the same time come down 30, some odd or like a endpoint security like the company. We just acquired on silo, some under and also the school it's ready.
So I think I'm more and more important and then also the new NP seven definitely help driving.
Not that direction inside our company now walk and a wider segment different the palm window server or data source theater and even per person.
To help him panto for these.
Ransomware attacks.
Great. Thanks very much.
Okay.
Thank you our next question from the line of task.
Oh Gee with Guggenheim Your line is now.
Hey, guys. Thanks, taking my question I had a question on the Equinix partnership can you just talk a bit about the go to market there will not just sold back.
The next I will just sold by more than that and how does the Rev. Rec out the Rev. Rec working in that case wouldn't be still a product or will that be recognized as the the service offering.
Probably most starting from go to market together and then we also what counts in Madrid more deeper partnerships, including.
So then put us on sort of Oncotype service offering but is a as a as a base of arent good starting up a.
Hi, good partnership.
Yes.
I think it's probably just a little bit are you talking about Rev. Rec [laughter] leases out from the last 24 hour, so well got it and that.
Just a classic if something on the guide so given that your product revenues were basically you know the grew at the same way didn't 18 and 19, what do we should assume the guest service revenues. There's no. There's no declined to 70 70 growth in 20, you should begin to have the same up 70, 70 girls and Tony that you added 19.
I think we actually included in the guidance service revenue.
For the year, So I think that'll probably give you a pretty good visibility to it.
In his prepared comments.
Okay. Thank you.
Thank you. My next question comes from the line of chain seasonal what else is high Visors. Your line is now.
Hi, guys congratulations on a great quarter.
I noticed the obviously the billings number was much higher than you thought and I'm just wondering.
What was the components behind that.
I think we saw very.
Very good performance.
You know many many geosouthern count the U.S. would.
Being a very very strong Geo, we also did very well in it in our emerging markets in the quarter. You know the it was strong and I gave you the revenue numbers, which is a pretty good indicator, but I think really if I were to call out in terms of where the strength was in the quarter I was very pleased with the U.S. and our and our emerging markets.
Congratulations.
Jason.
And I should have pardon me I mentioned, the Tam also who did a great job again I'm going to get in trouble and they did a very good job.
Thank you. Our next question comes from the line of Nick Yulico with Cowen. Your line is now open.
Great. Thanks for taking my questions I want.
Wanted to ask about fabric and just wondering if you can provide any color around the percent of 40 gig customers that have to put a fabric product and then maybe how that's trended over the past few years.
I think there's.
The minutes into question correctly, I think there's a very high correlation.
Tween.
Fabric customers and.
Fortigate products, it's fairly unusual for us to fail sell a fabric product to somebody who is not a fortigate products customer.
Right. Okay Quito helpful color around DSD when contribution in 2019 or any color on what that.
Contribution was in 2018.
Very very small I don't.
I'd below single digits best probably.
Okay, great. Thank you.
Thank you. This concludes today's question and answer session I would now like to kinda call back that Peter Salkowski for.
Thank you Sarah I'd like to thank everyone for joining the call today, unless you know that Fortinet, we'll be attending the following investor conferences in San Francisco during the first quarter, we'll be at Goldman Sachs Conference next week on February 11th and we'll get the Morgan Stanley Conference also in San Francisco on March 3rd presentations for both of these events will be webcast and links to these.
Webcast will be available on the Investor Relations website reported that if you have any follow up questions. Please feel free to contact we had a great rest of your day. Thank you.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
[music].