Fortinet Inc (FTNT) 2018 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fortinet Fourth Quarter 2018 Earnings Conference Call.

(Operator Instructions) As a reminder, this call is being recorded.

It is now my pleasure to introduce Vice President of Investor Relations, Mr. Peter Salkowski.

Please go ahead, sir.

Thank you.

Good afternoon, everyone.

This is Peter Salkowski, Vice President of Investor Relations at Fortinet.

I'm pleased to welcome everyone to our call to discuss Fortinet's fiscal results for the fourth quarter and full year 2018.

Speakers on today's call are: Ken Xie, Fortinet's Founder, Chairman and CEO; and Keith Jensen, CFO.

This is a live call that will be available for replay via webcast on our Investor Relations website.

Ken will begin our call today by providing a high-level perspective on our business.

Keith will then review our financial and operating results, and conclude by providing our guidance for the first quarter of 2019 and for the full year, before opening up the call for questions.

(Operator Instructions)

Before we begin, I'd like to remind everyone that we will be making forward-looking statements on today's call and that these forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected.

Please refer to our SEC filings, in particular, the risk factors in our most recent Form 10-K and Form 10-Q for more information.

All forward-looking statements reflect our opinions only as of the date of this presentation and we undertake no obligation and specifically disclaim any obligation to update forward-looking statements.

Also, our references to financial metrics that we make on the call today are non-GAAP, unless otherwise stated.

Our GAAP results and GAAP to non-GAAP reconciliations can be found in our earnings press release and in the presentation that accompanies today's remarks, both of which are posted on our Investor Relations website.

Lastly, all references to growth are on a year-over-year basis, unless otherwise noted.

I will now turn the call over to Ken.

Thanks, Peter, and thank you, everyone, for joining today's call to discuss our fourth quarter and full year 2018 results.

I'm pleased with our strong fourth quarter results.

Billings increased 22% to $649 million, and revenue was up 22% to $507 million, driven by solid growth in both American and EMEA.

Our non-GAAP operating margin for the quarter was 26%.

For the full year, billing increased 20% to $2.15 billion and revenue was up 20% to $1.8 billion.

Our non-GAAP operating margin increased to 22%.

On a GAAP basis, operating income more than doubled to $231 million, and our GAAP operating margin increased to 13%.

Our superior technology and broad Security Fabric architect contribute to the market share gain in 2018.

The improved sales, marketing, and continued investment in our channel also contributed to our growth.

According to a recent Gartner survey, 72% of respondents said that security was their topmost concern when it come to WAN deployment.

Fortinet best operates secured SD-WAN, with built-in, next-generation firewall, continued to gain significant traction across geographics and market segment.

In the fourth quarter, Fortinet signed a 7-figure deal with [BIKE MINE], a European retailer, with 4,000 stores in 26 countries.

We displaced a competitor as a result of our ability to provide integrated SD-WAN functionality and security in a single device.

Fortinet has received the most reviews of all vendors in the Gartner peer insight for SD-WAN and more than double any other vendor.

So we expect strong adoption of our secure SD-WAN offering for the next several years.

During the fourth quarter, Fortinet and Symantec announced our partnership agreement to provide customers with the industry's most comprehensive and robust security solutions across endpoint, network and cloud environments.

Today, we announced the release of a new series of high-performance FortiGate Next-Generation Firewalls, the new E-Series, including FortiGate 3600E, 3400E, 600E, and 400E, which delivers a combination of up to 30 GB per second threat protection, and 34 GB per second SSL inspection performance.

Additionally, the E-Series enable automations to implement intent-based Segmentation, providing smooth access control, continuous trough assessment, end-to-end visibility, and automated threat protection.

While 2018 may have benefited from the current enterprise product refresh cycle, we expect continued growth over the next few years due to 3 business drivers.

First, our portfolio of integrated secured SD-WAN and 5G product, which position us well to take advantage of the transition to edge and cloud computing.

Second, Fortinet's Secure Fabric offered the most broad automated and integrated security for end-to-end protection as automation consolidate towards a single security vendor.

And third, our security process unit, SPU ASIC technology, and a new high-performance E-Series product announced today, provide us with continued competitive advantage.

Our SPU technology delivers 10x the performance of other software approaches.

Over the next few quarters, we expect to increase our competitive advantage even more with the announcement of a new system on a chip SPU, and a network process SPU chip, integrated with new product for both cloud and edge computing.

For 2019, we expect to generate another year of better-than-market growth balanced with profitability.

We are excited about significant opportunity ahead and we will continue to invest in our business, while maintaining our goal of 25% operating margin by 2022.

I want to thank the Fortinet team, our partners and their ongoing hard work, for our customers, for their support.

Now I will turn the call over to Keith, for a closer look at our fourth quarter and full year performance, and our first quarter of 2019 guidance.

Thank you, Ken.

Before I start, I'd like to note, except for revenue, all financial figures are non-GAAP and growth rates are based on comparisons to the prior-year period, unless otherwise stated.

Slide references I make refer to the presentation posted on our Investor Relations website.

I'd like to now provide a summary of our solid fourth quarter performance.

Total revenue of $507 million was up 22%.

Product revenue of $201 million was up 24%.

Excluding a net benefit of $7 million from the revenue accounting change, product revenue growth was 19%.

Product revenue growth was driven by the new E-Series products, software sales, and growth in fabric platform solutions.

Service revenue grew 20% to $306 million.

FortiGuard, our security subscription offering, grew 19% to $165 million.

With all other services, including FortiCare, our traditional support offering, we're up 21% to $141 million.

FortiCare, which continues to benefit from customers transitioning from 8x5 to 24x7 support, was up 20% to $129 million.

As our strong revenue growth illustrates, the partial U.S. Federal government shutdown as well as concerns raised by Brexit and the slowing Chinese economy had no noticeable impact on our fourth quarter performance.

I would note our government vertical is well diversified and includes not only the U.S. Federal government, but also state, local and international government agencies.

Additionally, the U.K. and China are single countries within similarly diversified EMEA and APAC regions.

Before moving on with the fourth quarter results, I'd like to highlight our revenue performance for the year.

Total revenue for the full year grew 20% to $1.8 billion.

Product revenue grew 17%.

Service revenue grew 23%, moving over the $1 billion mark for the first time and represented 63% of total revenue.

At the end of the year, deferred revenue increased 26% to $1.7 billion.

Short-term deferred revenue increased 22%.

Returning to our fourth quarter, Billings grew 22% to $649 million, led by 23% growth in the Americas and EMEA.

Average contract length decreased by 1 month to 25 months.

Service providers and MSSPs had a seasonally strong fourth quarter at 23% of fourth quarter billings.

Service providers and MSSPs represented 11 of our top 25 deals in Q4 and include a 7-figure secure SD-WAN deal that included a customer acquiring over 20 high-end FortiGate products along with a range of other products and services.

Billings to large enterprises, excluding service providers and MSSPs, continued to outpace overall business with growth of 26% on a trailing 12-month basis, illustrating the strength of our enterprise business, the number of deals over $1 million grew to a record 47, beating the previous record of 40 deals set in the fourth quarter of 2017.

In the quarter, we closed a 7-figure transaction with a European Global 2000 multinational financial services company to use our FortiGate products to focus on internal segmentation.

Also, more than $1 million-plus wins last quarter was with a European-based supermarket chain that has 25% of the market share in the Netherlands.

The combination of security and SD-WAN functionality into a single form factor drove this competitor displacement.

As part of the -- of this transaction, the company purchased hundreds of entry-level FortiGates.

Network security billings increased 20% and continued to represent 3/4 of total billings.

Billings for non-FortiGate products and services grew slightly faster than our FortiGate billings.

The Security Fabric, which is the largest component of our non-FortiGate offerings, benefited from customers' recognition of our platform strategy, its value, performance and integrated security.

The Security Fabric includes software, secure switches and other hardware products and services.

Secure switches are sold together with FortiGates and related services, and represented 2% of total fourth quarter billings.

Total cloud billings for our top 5 public cloud providers continued to experience growth in excess of 100%.

Moving back to the income statement.

Our fourth quarter gross margin is 75.7%, was driven by the 40 basis point improvement in services gross margin to 87.3%.

For the full year, gross margin was 76%, up 70 basis points from 2017.

Fourth quarter operating margin increased to 25.8% or up 690 basis points.

The operating margin included a 340 basis point benefit from the required commission on revenue accounting changes.

Excluding the accounting change benefit, the fourth quarter operating margin would have increased to 22.4% or up 350 basis points.

For the full year, the operating margin was 22.4%.

Excluding the accounting change, the operating margin would have been -- would have improved to 19%.

Based on 605 accounting, the 3-year trend of normalized annual operating margin improvement starting with 2016, stands at 190 basis points, 210 basis points, and now 180 basis points for 2018.

While improving our operating margin these 580 basis points over the last 3 years, revenue grew at a 3-year compounded annual growth rate of 21%.

As Ken mentioned in his prepared remarks, we expect 2019 to be another year of better than market growth balanced with increasing profitability.

Slides 14 and 15 show a line-by-line comparison between our non-GAAP results and our non-GAAP -- our non-GAAP results and the non-GAAP results excluding the adoption of the new accounting rules for the fourth quarter and the full year.

Total headcount at the end of the year was up 15% to 5,845.

Net income for the fourth quarter was $105 million or $0.59 per diluted share, up 84%.

Net income for the full year was $320 million or $1.84 per diluted share, up 77% year-over-year.

On a GAAP basis, we reported full year net income of $332 million or $1.91 per diluted share.

The diluted share count for the fourth quarter was 175.8 million.

The non-GAAP effective tax rate was 24%.

Moving to the statement of cash flows summarized on Slides 10 and 11.

Free cash flow was $169 million, up 17% year-over-year.

For 2018, free cash flow increased 28% to $586 million.

In the quarter, we repurchased 1.3 million shares totaling $92 million.

For the full year, we repurchased 3.8 million shares, totaling $209 million.

We're outgrowing our Sunnyvale office space and are constructing the second building adjacent to our existing building, which we expect to occupy in the second half of 2020.

Including spending on this project, we expect total first quarter capital expenditures to be between $15 million and $20 million and total full year capital expenditures to be between $120 million and $140 million.

As I turn to the guidance provided on Slide 13, I'd like to remind everyone that the forward-looking disclaimer Peter presented at the start of the call applies to the guidance I'm about to provide.

For the first quarter, we expect billings in the range of $515 million to $535 million, revenue in the range of $465 million to $475 million, non-GAAP gross margin of 75.5% to 76.5%, non-GAAP operating margin of 18% to 18.5%, non-GAAP earnings per share of $0.37 to $0.39, which assumes a share count of between 176 million and 178 million shares.

We expect a non-GAAP tax rate of 24%.

We are closely watching the widely reported concerns of potential softening of global economies.

With that said, it is important to note that we are seeing healthy pipeline growth in our business, and we believe we are well positioned to continue to grow faster than the security market in 2019.

For 2019, we expect billings in the range of $2,450,000,000 to $2,500,000,000; revenue in the range of $2,060,000,000 to $2,100,000,000; total service revenue in the range of $1,330,000,000 to $1,360,000,000; non-GAAP gross margin of 75.5% to 76.5%; non-GAAP operating margin of 22.5% to 23.5%; non-GAAP earnings per share of $2.05 to $2.10, which assumes a share count of between [180 million and 183 million] (Sic-see press release 181m and 183m).

We expect our non-GAAP tax rate to be 24%.

We expect cash taxes to be between $53 million and $59 million.

As this guidance indicates, we remain committed to balancing growth with increasing profitability as we work to achieve our non-GAAP operating margin goal of 25% for 2022.

Before I turn the call back over to Peter, I would like to thank our partners, customers, and the Fortinet team for all their support and hard work.

I'll now hand the call back over to Peter.

Thank you, Keith.

Operator, we're ready to start the Q&A session, please.

(Operator Instructions) And our first question comes from the line of Shaul Eyal with Oppenheimer.

Ken or Keith, so the product breadth is undoubtedly noticeable from a channel perspective, whether it's SD-WAN, some 5G-related transactions, the NAC, and as well as the new E-Series products.

And you guys are moving in all market direction and all infrastructures.

Now we all view Fortinet as a pure-play security company, but maybe we should start thinking of Fortinet as becoming more of an infrastructure play.

Just, maybe high-level view, how do you think about it?

This is Ken.

We still want to focus ourself as a security company, especially now with security.

And but the security, as a percentage of IT spend and to keep increase high percentage, because security, addressing the application content, the user device and the region level, which the basic networking cannot address.

So all this become much more important with the later, the 5G SD-WAN, the digital transformation.

And what's unique about Fortinet, we also, when we design a security, we want to design in into the infrastructure, like from 10 years ago, we start to design the Wi-Fi controller within FortiGate . And then, 4, 5 years ago, designed the SD-WAN controller inside FortiGate.

And also, going forward, the 5G designs in security.

That's where -- so we basically, you can look at the FortiGate product, which we designed actually to incorporate some of the infrastructure function, which is more of an important for a lot of service provider, and also for enterprise, and then, for them to design the infrastructure together with security, inside our add-on security later.

So that gives us a huge advantage, like when there's a new infrastructure keep expanding like all the SD-WAN, going forward, the 5G, and also, working closely with a service provider, whether in the cloud or edge computing and also IoT/OT security.

So that asset advantage we have, and we do think in more long-term for what security, the infrastructure should be, and then, starting to invest in R&D early.

Got it.

Got it.

And then, maybe one for Keith.

Just as we think about the channel, the partner strategy, the way you've been compensating partners and at VARs, pretty much the same dynamics that we've been seeing in recent quarters, recent years?

Or have you been seeing any change or implementing any change?

I think when I talk to the channel leadership team, I think I probably described the last 6 to 12 months as being one where there was more focus on individual segments of the channel, whether that was SMB, MSSP, even the larger parts of the channel.

And I think that programs are probably more tailored now, whether they're resellers or distributors.

And I think the programs, when I say tailored, are probably more targeted in terms of where we're seeing the performance from our channel partners.

And our next question comes from the line of Jonathan Ho with William Blair.

Let me just start out with, maybe, some additional color on your SD-WAN driven deals.

Can you maybe talk about what percentage of the new deals are now coming and sort of influenced by this SD-WAN demand?

I don't think we have the detailed data for it.

But definitely, we'll see the pipeline increase more quickly, different from other SD-WAN player, which they only have SD-WAN function.

We designed with security, which is the top concern for all the WAN expansion.

And at the same time, this also other -- we see the other strong drivers for the future growth in the next few years, even beyond the refresh from underpriced network and security, which probably will last a few more quarters.

But for this expanding into SD-WAN into 5G will be at least a few more years, keep growing, and then, we are very uniquely positioned and has designed this a few years ago and we started to benefit from early investment.

Got it.

And then, with regards to your intention-based firewall, can you talk a little bit about how that differs from a traditional next-generation firewall?

And maybe, how does this new firewall fit within the emerging 0-trust models?

Yes.

The traditional firewall unit deployed in the -- on the corporate enterprise edge on the border, so there's a trust inside zone, and there's a trust outside zone there.

But this intent-based segmentation just can deploy wherever the inside enterprise next to the server, next to the data center, next to the segment-driven department, and also some other device, which let's try to be deploying the high-speed LAN environment compared to before, the traditional firewall, once I connect the WAN, how do I connect the LAN?

So this is ready, high-speed, easy deployment, and also leverage a lot of AI machine learning to automate the time out as an intrusion -- also the internal security issue, which count as a majority of security concern now.

So that's where it's a hot move inside into the enterprise, and also, how to deal with the high-speed environment in automated response way.

That's how this -- the new E-Series are addressing right now.

So we see a quite big -- quite quick ramp up because this can give the whole infrastructure security.

It's not just some kind of border security.

And our next question comes from the line of Sterling Auty with JPMorgan.

So Ken, I appreciate the commentary around fabric, and especially the long opportunity that still in front of you.

But my sense is that, still, the biggest portion of the business, quarter in and quarter out, at the moment, is still kind of the core traditional network security, and I'm curious in the enterprise, the deals that you're winning, what are you hearing as the main drivers?

Is it just the straight outperformance of speeds and feeds?

Is it the integration across your portfolio?

Or the breadth of your product offering?

Or some combination thereof?

The speed started to become more and more important, whether with the speed for the whole infrastructure increased 5G of internal segmentation deployment.

So that's where we see more and more the mandate.

And also, one thing Keith also mentioned, because the fabric also involve imposing some of the switch, some of the Wi-Fi access AP.

So that's because all of this will be part of the total infrastructure.

And the traditional firewall starting kind of being replaced, we call the Third Generation, it's around infrastructure security, how to address both inside enterprise and the cloud, the mobile, the endpoint all together.

So some of them will be kind of an innovate design internally, some will be partnered with some other partner, like Symantec, some other too, to address the hostings together within the whole industry.

So that's where we see the transition is kind of a different than the part.

You have to have a different part of infrastructure working closely together to integrate, to automate together.

So that's where -- especially the enterprise that we see some consolidation going on.

That, we feel, is the other driver.

So we do have the fabric approach, both working with our own product, and also with a partner product together.

So we feel this change will last for a few more years.

And because this is different than the last time, 4, 5 years ago, replacing the traditional firewall with next-gen firewall UTM.

Now it's ready to -- the whole infrastructure need to be secured altogether.

This is Keith.

Let me just add a couple -- give a little more context on that.

If you look at a couple of verticals when I talk to the sales leadership with Ken, I think in the financial services, you're seeing ROI and speed be at the top of the list.

And another one would be retail.

I think there you're seeing SD-WAN and branches be top of the list.

And then, if I look at the DSOs in the quarter, I think it popped up a bit.

Is that an indication of the linearity and more back-end loaded?

Or was there some other driver to it?

Because I'm looking at that as well as kind of the first quarter guide and just wondering if there's read-through here?

No.

I think the -- for comparability purposes, I think we lose a day because of the conversion from 605 to 606.

But I don't think -- I did notice last year -- last year being 2017, Europe finished up very early in the quarter and went after the holidays.

I think folks are working throughout December on both sides of the ocean this time.

Okay.

And then, last one, if I could sneak it in.

As you think about how you've laid out the guidance for 2019, where would you say the points of toughest comparison are through the year?

And how would you kind of characterize the seasonality of the guidance, first half versus second half, versus your traditional business?

I think the headline is that 2019 guidance looks a lot like 2018 guidance in terms of where we started, whether that's on the top line and whether that's on the growth.

I think our pipeline, we feel very good about the pipeline that we're looking at, at the moment.

There's a certain note of caution in some of the things that I mentioned in the script, not necessarily directly relevant to us, but I think we're watching the spillover impact.

But to come back to your original question, I think the model for 2019 looks a lot like the model did for 2018 in terms of the timing of things.

(Operator Instructions) And our next question comes from the line of Fatima Boolani with UBS.

I have 2 for Keith.

Keith, the first one is just around your implied product revenue guidance.

So if I did my math right, I'm shaking out maybe a little bit ahead of where we were expecting anyway.

So I wanted to plug into that, and maybe get a sense of what you -- what is giving you confidence around that product growth trajectory.

And as an extension, as we sort of lap some of the tax reform impacts of 2018, as we are lapping some of the specific incentives into your sales capacity that you provided for product growth in '18, to what extent are we sort of lapping that, and sort normalizing those effects?

And a follow-up as well.

So kind of taking your last point first.

I continue to think that a comment we made very early in last year about changing 50 comp plans is probably having an overblown impact.

For people, it's not doing what people are suggesting it is.

But to your original point, I think when we look at our pipeline, we feel very good about what we're seeing in terms of the business.

I don't think there's something that we're seeing that's evidence of a slowdown.

We feel very good about the things that are coming online as we move through the year, whether that's the new product offerings for the 3400 that we talked about, the 400 product offerings, the SD-WAN products and what we're seeing there.

And I'll try to expand on the comment that was made, I think I was talking to Jonathan a moment ago.

I would offer that when I benchmark the pipeline growth of SD-WAN against other solutions, if you will, it benchmarks pipeline growth, benchmarks very well against other growth that we see.

When I follow it up and benchmark that against the close rate, again, it benchmarks well when we compare it to other parts of the business.

So I think there's a lot of callus as we move through the year.

That's really helpful.

And just around your service provider business, so that sort of snaps back to some of your historically higher level of the proportion of billings, I think you said 23%.

But at the same time, we've picked up a medium or cautious tone from some of your tech peers around data center spending and service provider spending posture.

So what is really driving that momentum for you?

And really, how are you sort of bucking that trend that we've picked up negatively from some of your other tech peers?

And that's it for me.

This is Ken.

First, I think the service provider will start to play a more important role in the security space.

And also, with the spending of infrastructure, SD-WAN 5G.

So through the next few years will be also very strong for service provider keeping -- spending their own infrastructure service, and also add a security service.

It's also interesting.

We -- service provider unit is the biggest sector for us.

We're supporting them from -- or beginning more than 10 years.

We can see the trend going on there is very -- security has become a higher, higher percentage.

And I know sometimes, like a few years ago, whether servicing more to the cloud, attempting kind of a slowdown of the 5G, whatever, not quite there yet, slow down the service provider spending a little bit.

But since that didn't turn around.

So that's probably will be our strong driver for the next few years.

And we also have all the product, all the other service timing is very good, and we'll feel pretty confident and give us additional gross driver for the next few years, beyond the enterprise kind of refresh.

Because the design has weathered the SPU ASIC technology, the new product, the SD-WAN, the 5G security.

Eventually, it will benefit all the service provider -- and the price the customer love is none of the other strong competitor actually, kind of the internal develop or integrate as good as we are for this kind of a security function with infrastructure function, and also, closely working with service provider for more than 10 years.

So that gives us a pretty good confidence for the next few year's growth.

And our next question comes from the line of Melissa Franchi with Morgan Stanley.

This is Hamza Fodderwala in for Melissa.

I had a quick follow-up to a question that was asked earlier on the product revenue guidance for 2019.

I think by my math, implies about 9% growth.

To what extent does that reflect the moderation based on some of the lapping effects that were mentioned earlier?

Versus just general caution on some of the macro factors?

Whether it be tariffs, or China, or whatever else?

Yes.

I think the focus is more on the latter than it is on the former.

But I mean, I think, again, I think the pipeline that we're looking at looks very, very strong.

And whether that's an SD-WAN use case, which I talked about, which is going very well, very excited about seeing the new 400, 600E products building out the midrange product family, plus the 3400, the 3600 that Ken just talked about, and the new functionality that that's bringing along.

I think what we'd really like to do here is kind of watch what happens with the U.S. government, Brexit and the exit, whether they're going to crash out or not and China as well.

And again, I don't feel that we have large exposures in any of those geographies.

In fact, they're quite small.

But it's more kind of wonder of if we're going through this process, could those things start spilling over into the larger economies.

Got it.

And then, on the tariff impact, to what extent was that negative or even a positive impact for you in Q4?

We did pick up some of our checks that there were customers pulling forward spend in advance of price increases.

So I was wondering if you noticed any of that this past quarter.

And that's it for me.

Had not heard that, and the tariffs impact a very small subset of our products.

So I would be surprised if we actually -- if it may have been happening to other vendors, but I would not be expect that -- see it happen here.

And we're not changing prices around tariffs, so I don't know that they would have that incentive for Fortinet products.

And our next question comes from the line of Andrew Nowinski with Piper Jaffray.

I just wanted to ask a question on the service provider segment.

Clearly, strong results this quarter and I was just trying to determine, I guess, how sustainable that is going forward?

And if you could just weave in, maybe, sort of any update on the competitive landscape in that space, given that Palo Alto recently launched a new appliance targeted at the service provider segment.

I'll kick it off, and hand over to Ken for the hard part.

Yes.

I think the service provider has always been a very strong part of our business.

It's also been one that, as a percentage of business, has been fairly lumpy from quarter-to-quarter.

Q4 is typically a very good quarter for the service provider part of our business.

So we're very pleased with the results.

I think in the quarter itself, we have historically done very well with MSSP segment of that business as well as the infrastructure.

And we saw deals in both parts of that business in the quarter.

Yes.

So service provider, they're first, a very long sales cycle.

Probably 1 to 2 years to sell into a service provider.

And also, they need to have environment more high performance and also more a reliable environment.

And also, it's a very technical buy.

It's different than some competitor using the marketing power to influence some of the nano tech buying enterprise.

But service provider, they have to be FortiTest the product, and there is both themselves and also the third-party validation.

So that's where we're working with service provider for more than 10 years, and pretty much all the service provider, major service provider.

So our customer and working very close with them, and also design a function future within for many years together, different than some other competitor announced their product or service provider, but have not seen anything come out yet.

And on the other side, it's like with SD-WAN, with the 5G, with the new progress in the infrastructure, there's also a lot of opportunity, and the security become more complex for the enterprise and the service provider actually can provide additional value-added service.

So that's where we are behind the service provider to support in their future growth in a security space.

And so we do expect, I think it is also some sort of, like I said, it's running a lot of high-end product for the core, and also could be a lot of edge computing like relate to the IoT, with the OT some other part.

So they need both the high end, and also the edge product working together and so we have the advantage of that.

And also, like that, the product we mentioned in the earnings call, whether the 5,000, the 7,000, we have been shipping that product for a couple of years already, meaning we cut a few years already.

And so they really need some time to get in the space and we don't see so many of our competitors come close to the position we have today.

Great.

And then, maybe just from a geographic perspective.

You had fairly similar growth across all regions in 2018, on an annual basis.

And so as I look at your 2019 outlook, should we, again, expect a balanced growth across all regions in 2019?

Yes.

I mean, that's how we assign out the quota.

We were very pleased with the consistent execution across the geographies, particularly in the fourth quarter in different parts of the business.

But yes, that's how we model the business.

And our next question comes from the line of Brad Zelnick with Credit Suisse.

I've got 2 questions.

First, again, on service provider, was a bright spot this quarter.

And you called out the opportunity in 5G and edge use cases as a key opportunity for you.

And can you maybe talk about the demand for your virtual appliance in that market, and perhaps, more broadly, how was the shift to virtual compared to your expectations, maybe 1 year or 2 ago?

And what do you think that looks like into the future?

Yes.

We also have a huge advantage on the virtue and also -- we also call it a virtual SPU.

So that's the architecture we're using with a lot of our call provider in some virtual environment.

And at the same time, they also need to secure the core of their -- whether the data center or the cloud.

And then together with the edge, which also needs some kind of an appliance in the edge, in the field there.

So that's where you can see both the cloud, the virtual cloud, growing quite well.

And we also -- we kind of offer what we call the [hurdle] to integration with the multiple cloud provider, with a more broad function then other competitor, which give us more advantage.

It's also part of the fabric solution.

So that's where -- whether you go to the cloud or virtual, you also need to make sure different applications and also different cloud provider can working together to help customers solve the issue.

So that's where we do the integration much better and also more broad offering compared to some of the competitors.

So that's where, combined, the virtue is the physical together is the advantage we offer to service provider.

That's actually very helpful.

And Ken, we keep hearing great things about your products from the channel.

And I feel like everybody likes to focus on some of the other very large public companies in network security.

But I'd be curious if you can share any observations about some of the other ones that are often times forgotten about, names like SonicWall or WatchGuard.

What do you see?

Do you ultimately believe that the lower end of the market or the smaller players out there eventually get consolidated?

And are you coming across them in the field competitively?

There's a 2-part.

First, the security is very dynamic environment.

Been in security for almost 30 years.

You need to keep up the innovation.

So that -- if some of the companies too slow on the innovation or kind of cannot follow the trend, their growth will be slowed down or even have to depend on acquired company to grow.

And then, acquired company, the challenge really, how this acquired company and some other to integrate with this in functioning, this in product.

That's always a challenge for some of the big company.

So some of the other smaller player actually, once they cannot really reach certain size, the investment, like -- we spend billions of dollars in the ASIC technology for the SPU, and also the economy of scale, also started working well.

So that's also making some of the smaller competitor have less, less advantage.

When security reach higher speed, more broad offering, so that's where the consolidation also started happening in the space.

So I feel somewhat a smaller competitor probably started losing some of the edge there.

And there is still a lot of new niche market.

That's where, every year, there's a lot of new company come up to the space, play some of the new function, new application, new niche.

But it's really, the niche market can only address some part of enterprise.

If they cannot expand in, cannot integrate, cannot improve the performance, then they have difficult time to grow beyond like the $100 million or $1 billion in there.

So that's where we see some of the old company, long-term companies, that is slower on some of that innovation and also the growth.

And we feel that, with the consolidation going on, probably we're now looking more good for some of these companies.

And our next question comes from the line of Walter Pritchard with Citi.

Two questions for Keith here.

Just on the Q1 seasonality, it did feel like you had a pretty strong fourth quarter and the Q1 seasonality, especially on billing, seems a little bit light of what it usually is, if I look Q4 to Q1.

Is the simple explanation there the strength in Q4?

And then, had a follow-up on another metric?

Yes.

It is just the pretty strong performance that we had in the fourth quarter.

Clearly, an outperformance.

Great.

And then, you did talk about, I think, 2% of the revenue was from -- works from switches.

Could you maybe -- I don't know if that's the largest kind of the, kind of non-security products?

Maybe you could help us understand, all in, the phones and cameras and the access points and any other things that weren't excluded in that 2%?

How much of the either product revenue or total revenue is represented by non-security products?

So I think the piece of that, non-FortiGate includes secure fabric, which is the lion's share of what you're talking about.

It also -- those are some other things, professional services, training.

We actually include phones and cameras and perhaps the 4010, I'm not sure, in that particular group.

But coming back to what truly makes up secure access -- or secure fabric, switches are the purer -- of products.

It's the largest of the products.

So what you have that remains is 10 to 11, 12 different solutions that we offer in both hardware and software.

And the one metric I would offer, if you total up all the software billings in secure access, they're much greater than the secure switch billings are.

And I think when you start looking at our -- when we start talking about our margins, and while we're pleased with what secures switches bring to us as part of a deal in terms of the product margin, we understand that it does not attach quite as much service.

But It's not the drain on margins that some people may think.

And also, keep in mind, in that particular product suite I just described, software is much larger than switches, and it's generating a lot more margin for us.

Yes.

Also, and trying to make it clear, we don't sell the switch separately.

And all the -- we call it FortiSwitch wholesale with the FortiGate together.

So basically, FortiGate control the switch and do some isolation, segmentation, and also sometimes, some kind of a weather controller function there also.

So that's where all the security function inside the switch and working with FortiGate, but switch is not sold separately.

It's a part of what we call a fabric solution.

And that's together with some other, the Web security, email security, and point security all together.

So basically it has to be sell-together instead of sell-separately.

So that's the switch is, really -- we don't sell switch separately.

And our next question comes from the line of Gabriela Borges with Goldman Sachs.

Either for Ken or for Keith, I think there was a little bit of earlier color on your plans for the channel this year.

I was hoping you could also elaborate on your plans for hiring for the internal sales force, how you're thinking about the pace of hiring versus last year.

Where are you prioritizing adding headcount?

And for Keith, any color on productivity assumptions, that would also be really helpful.

Sure.

Kind of going in reverse order.

Productivity assumptions.

We had very strong productivity, particularly in the fourth quarter last year out of the sales team.

I have not, to be cautious, I am not modeling sales productivity into the guidance.

Increases, if you will.

So I think that's an appropriate way to go about it.

I think, in terms of where we're adding salespeople, in terms of the cadence of hiring, perhaps just a little bit behind our revenue growth number, and we're trying to keep our sales hiring aligned up with our revenue growth number.

And where we're actually targeting is as we've talked before, is as we continue this expansion into the enterprise, I think one of our first areas of interest is finding experienced enterprise sales people and bringing them on board.

That's not to say we're not investing in other places and certainly, the channel, as I alluded to earlier, as we continue to maintain and grow the leadership position in the SMB and the channel business, you're seeing investments there as well, as well as the carrier and SSP and the commercial segment of the business.

But I would say kind of in the order that I just gave in terms of priorities.

That's very helpful.

Yes, please?

Yes.

We also -- well, keeping invest in the market in both in the, like create a pipeline, and also have a seesaw level kind of interest there.

And I think that's where we see one of the fast-growing areas for us is really the enterprise, especially enterprise in the U.S So we're -- we come from a relatively small base, but we're keeping -- growing much faster than any other competitor, and also above company average.

So we're keeping investing in that area.

And also we have a better tool to tracking, whether the CRM, ERP, whatever, all the tools all starting working together and gave us better visibility for the pipeline, for the productivity and also how to kind of different investments, see how the return of -- for each investment so I think we're starting to get -- try to be more efficient going forward.

That's helpful.

And the follow-up is referring back to the prepared remarks.

So Ken, you mentioned 2018 was a good refresh year, and then, you mentioned a few really interesting company-specific drivers for Fortinet going to 2019.

I've always thought the refresh was interesting because it gives you a foothold to try to displace competitors as change is happening in customer environments.

But I'd love to understand how you're thinking about the refresh piece of this, going into 2019, at the industry level.

Yes.

The first, the refresh, I keep mentioning, really, is more in the enterprise space.

So we're relatively small compared to some competitor in enterprise that grow much faster.

So we're -- and also, the refresh, it's different, not as replacing the edge firewall or the traditional firewall with new firewall.

But it's really try to consolidation and also integrate, automate different pieces together.

So that's what lasts maybe longer and also, making the deal also bigger, if you have more broad product offering or some partners, other different player in the space.

So we feel the enterprise refresh probably will continue for a few more quarters, and even maybe a couple of more years because all this consolidation and also market product working together, well, we'll keep doing that.

And we also keep growing enterprise space above average.

On the other side, we also see the new infrastructure like we mentioned, SD-WAN, the 5G and the service provider play a bigger role, more percentage into the space, also helping driving.

And also, the timing of our new product, new SPU ASIC chip also was very good because it takes us 3 to 4 years to design.

And since that is finally coming out now, and that we also benefit from all of these.

That's where I mentioned, there's a sweet driver will keep us growing because the broad product on the fabric more integrate to feed enterprise or consolidation integration.

And also, the new product and also the 5G SD-WAN in the service provider, I think, all these 3 drivers are beyond the refresh and I think will be -- will help on the growth for the next few years.

And our next question comes from the line of Michael Berg with JMP Securities.

I wanted to ask real quick on the Federal piece.

I know in the quarter, you mentioned that it wasn't a material impact.

But looking at the guidance, and even through the entirety of fiscal '19, what are you seeing in terms of the pipeline?

Are things getting pushed?

Or are the sales cycles being extended?

Or how can I think about the Federal piece of the business, given the shutdown?

So I think the -- to kind of frame it up, first of all, I think some time ago, we disclosed the Federal -- or the government vertical.

It was, pardon me, 15, it was probably the second or third largest vertical, but it includes, not only the U.S. Federal, which is probably the smallest part, but also includes state, local and international government entities as well.

So in terms of a direct impact to the Federal shutdown, together with the fact that I think 7 of the 9 agencies were funded, given the size of what the Federal government is to our particular business, I'm very unconcerned about it.

My concern stems from, if this thing, if we continue to go, if we close it down again and it starts becoming a much broader economic issue, then I'd have concerns about it.

Okay.

And then, a quick follow-up.

How big of a business can I think about Fortinet filling into the core of a data center?

We've seen some weakness in peers.

How can I think about you guys talking to the data center?

I don't think much slowdown in the data center.

But we're mostly working with service provider, both sell into somewhat the infrastructure and also sell this as service provided offer secured service to their customer.

Because we launched a product like the high-end 6000, 7000 series popular 1 to 2 years ago.

And since that has ramped up, we have not seen the data centers slow down.

Keith, anything?

Yes.

We're both positive, because neither one of us really have any data that suggest there's a slowdown.

If you're talking about the cloud providers, and some of their plans or something like that.

But regardless, it doesn't -- we're not seeing something impacting our business.

And our next question comes from the line of Daniel Ives with Wedbush Securities.

A lot of the questions have been asked.

But I guess, maybe to frame it, I know there's a lot of naysayers, including many on the call, on your growth.

And you continue to defy the skeptics.

What do you think investors are missing, especially on the large deal side, in terms of what you guys are doing versus competition, as well as, maybe going forward, the growth opportunity versus, I think, some of the noise out there?

I'll just frame it from there.

For me, as an engineer because we do invest in some of the long-term innovation, and like from the SPU ASIC chip level to with some infrastructure, some other things, and also try to see how the next 5 to 10 years, we may keep an improving position and make a difference in the space.

So that's where some time could be too technical, could take a long time to explain to some of the investor.

So they are always joking me about I sometime go too deep, too technical.

So that part, I still feel, has a lot of value, a lot of potential, and also different than some other competitor.

Maybe more short term, some more finance-focused.

But we're more focused in the technology, the long-term to make a big impact into the space.

So that's the result, as whether the innovation, like the patent we have, like just reached over 600 patents, most of them internal innovation.

And also, the new product and a lot of new technology function there.

But like I said, so we are working in winning the technical buyers space, whether in the Fortune 100 company, SP 100.

I think we have 90 of the SP 100.

And also, the service provider, which is very technical buyer.

And also, the third-party testing assets from the government, from some other agencies.

Whenever there is an IP testing going on, we're doing quite well.

But compared to some of the other competitor more on the market, some other sell side, we're very improving ourselves.

But at the same time, we also want to keeping the innovation culture we have.

And also, keeping -- invest in the technology into the product.

So that's where we'll be.

And at the same time, we also want to balance the growth and with the margin, right?

It's not like a growth without cost.

You see money, and keeping -- pushing money on the GAAP-based.

So we want to keep in some balance among the growth, and also some of the margin, both on the GAAP and non-GAAP cash flow base.

So that's where, from a shareholder return in the last -- so this year will be our 10-year anniversary of the IPO.

So the valuation has start growing more than 10x in the last 10 years.

So that's where we also kind of, we feel, sometimes, you may need to whether you're looking back or looking forward for a long time to see some of the strategy we planned.

I would offer that -- probably echo what Ken said.

I think, one, clearly, we're executing on a balanced growth approach, right?

We're balancing, I think, for the top line, adding to the bottom line.

And I think that I look at the founders of the company, they are long-term investors, and I think that plays very well with them.

And I think, also, the experience -- I think people sometimes undersell the experience that we have in the technology side with the founders and others, about where the direction of the product -- of the market is going over perhaps a longer period of time than perhaps looking at 90-day cycles.

That's great.

Great.

Great.

And just on 5G, I mean, especially if we look at where that's going in the next 18, 24 months, I mean, do you feel like that's a clear competitive advantage you have, especially just given the technology and where you guys play going forward?

Yes, that's really -- you have to drive the growth for the next few years, even 5 to 10 years because there's a core and how to secure, really, to the cloud side and the core data center side.

And then, because of our high-speed application, and also how to secure the edge related to all this IoT, OT and how this, like a virtual combined with the physical and the -- so that is that.

And also see the 5G also more driven by the SDN, the software-defined networking, and also kind of will be related to the investment we made almost 10 years ago in the Wi-Fi, combined with Wi-Fi controller inside FortiGate, and then 4, 5 years ago starting port SDN.

So SD-WAN controller inside FortiGate.

So all this has to be combined together to play the 5G, and also need at least like 5 to 10 years investment and also continue working with service provider with different part of infrastructure to play the 5G.

And also, even some different vertical has some different requirement.

So different application, different -- like whether related to the different kind of IoT vertical.

It's quite a complicated, but also need a long-term investment and also need to design together like we -- [also] we had sort of designed a security and infrastructure together and also -- so that's for 5G has to be in there like not just about -- talk about for a few weeks or a few months, then you have something come out.

This really has to take years of investment.

And also combined with technology, the other part, working with service provider for years to come up the solution.

So that's where we feel pretty confident about the 5G, and will help drive for the next probably 5 to 10 years.

And that concludes today's question-and-answer session.

So with that, I'd like to turn the call back over to Mr. Peter Salkowski for closing remarks.

Thank you, Andrew.

I'd like to thank everyone for joining the call today, and let you know that management will be presenting at the following technology conferences during the first quarter: We will be at the Goldman Sachs Conference on February 12, and the Morgan Stanley Conference on February 25.

Both conferences are being held in San Francisco.

So we look forward to seeing many of you in the Bay Area.

If you have any follow-up questions, please feel free to give me a call or send me an email.

Have a great rest of your day.

Thank you very much.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program, and you may all disconnect.

Everyone, have a wonderful day.