Juniper Networks Inc (JNPR) — Q4 2018 Earnings Call Transcript

Thank you, operator. Good afternoon and welcome to our fourth quarter 2018 conference call. Joining me today are Rami Rahim, Chief Executive Officer; and Ken Miller, Chief Financial Officer. Today's call contains certain forward-looking statements based on our current expectations. These statements are subject to risks and uncertainties, and actual results may differ materially. These risks are discussed in our most recent 10-Q, the press release and CFO Commentary furnished with our 8-K filed today, and in our other SEC filings. Our forward-looking statements speak only as of today, and Juniper undertakes no obligations to update any forward-looking statements. Our discussion today will include non-GAAP financial results. Reconciliation information can be found on the Investor Relations section of our website, under Financial Reports. Commentary on why we consider non-GAAP information a useful view of the Company's financial results is included in today's press release. Our Q4 '18 and fiscal '18 results and forward-looking guidance are provided under ASC 606, which we adopted on January 1, 2018, on a modified retrospective basis. Following our prepared remarks, we will take questions. Please limit yourself to one question and one follow up. With that, I will now hand the call over to Rami.

Thank you, and good afternoon, everyone. We experienced mixed results during the December quarter. Total revenue of 1,181 million was below the low end of our guidance as another quarter of strength in our enterprise business was more than offset by weaker than expected trends with our cloud and service provider customers. Non-GAAP EPS of $0.59 came in slightly above the midpoint of our forecast due to healthy gross margins, continued cost control, and a lower tax rate. While we are disappointed by our Q4 sales, we are seeing success in several areas of our business that we expect to continue through the upcoming year and should help drive the business back to year-over-year growth at some point during the second half of 2019. We are particularly encouraged by the momentum we are seeing in our enterprise business which grew 13% quarter-over-quarter and 14% year-over-year due to broad-based strength across product and geographies. Given the breadth and the strength in our enterprise vertical, strong customer interest in new platforms such as Contrail Enterprise Multicloud and MX10003 along with the investment we are making in our enterprise go-to-market engine, we remain optimistic this business will continue to see healthy trends over the coming quarters and remain a growth driver for Juniper in 2019. I think it's also worth mentioning the success we are seeing in security, which grew 34% quarter over quarter and 18% year-over-year and surpassed 100 million in quarterly revenue for the first time in several years. Our new products continued to resonate in the market and drive broad-based strength across a wide variety of customers. Our recently introduced high-end firewall line card saw particularly strong demand, which helped drive a high volume of deals greater than 1 million. Based on the momentum we're seeing, we remain confident that our security business will grow in 2019. We're continuing to see success in our software business which grew 32% year-over-year and accounted for more than 10% of total revenue during the fourth quarter. This strength was driven by a combination of on-box and off-box offerings with revenues from our Contrail family increasing more than 100% in the quarter on a year-over-year basis and rising more than 200% for the full year 2018. While we do not expect our success to be linear, we believe software will continue to increase as a percentage of our revenue over time, especially as we introduce new products and new business models designed to better monetize the value of our software offerings over the next few quarters. Conversely, we continue to experience weakness within the cloud and service provider verticals. Our cloud business has remained challenged over the last few quarters as several of our hyperscale customers have continued to run their networks harder. While continued support growth is driving confidence that we are holding our hyperscale footprint and the MX to PTX transition is now largely behind us. The pace of this port growth in the portion of our cloud customer's network where we have historically played is slower than we expected. Based on what we're hearing from our customers, we believe wins and new use cases will be needed to drive the cloud growth we guided for at our November Analyst Day. We are laser-focused on capturing these opportunities and view the 400 gig transition as an inflection point that will present the opportunities for us to take share starting later this year. Our current product roadmap and strong customer relationships are driving a high level of confidence in our ability to secure these net new use cases in the cloud, particularly in the data center where we have relatively low presence today. While business model pressures and the impact of consolidation may continue to impact service provider spending for at least a few more quarters, with our MX 5G product refresh and Contrail Solutions to drive telco cloud transformation, we believe we are well-positioned to capitalize on carrier 5G deployment and remain optimistic regarding our partnership with Ericsson. We believe these products and partnerships should position us to deliver better service provider results later in the year. We remain confident in our strategy and that we are taking the necessary actions needed to win in the market as each of our industry verticals transitions to cloud. We believe these transitions are likely to drive major technological change that will create significant opportunities to disrupt the status quo and take share. We intend to capitalize on these opportunities and while some of these changes may create disruptions in the near term, we believe they will play a critical role in returning the business to year-over-year growth at some point during the second half of 2019. Some of these actions we are taking are as follows. First, we have made significant changes to our go-to-market structure in order to better align our sales strategies to each of our core customer verticals. While many of these changes have been made over the last few months and may drive some near-term disruption in our go-to-market engine, we believe more closely aligning our sales leadership and product management teams across our core vertical will result in greater accountability, better products, and a superior customer experience. We are also flattening our go-to-market organization and reallocating captured savings towards placing more product-sharing sales reps into the field. We believe these actions will position us to see improved sales force productivity later this year. While our Chief Customer Officer left Juniper earlier this month, we are confident that the changes we have implemented are supportive of our strategy and should position Juniper to better capitalize on the market opportunities that will unfold over the next two years. Second, we are on the verge of introducing several new products over the next few quarters that we believe will further strengthen our competitive position across our service provider, cloud, and enterprise market. By the end of this year, we expect that nearly all of our product lines will have undergone a major refresh that should enhance our position relative to key competitors. These anticipated offerings will include new MX line cards that will strengthen our ability to capitalize on carrier 5G initiatives, new 400 gig platform that will improve our ability to capture data-centric footprint particularly in the cloud, and new enhancements to our Contrail Enterprise Multicloud platform that will help our mid to large enterprise customers transition to a multicloud world with increased simplicity and reduced cost. We also plan to introduce new silicon photonics capability that will further enhance our competitive positioning, and we plan to share more with you on this topic at the upcoming OFC Conference. We believe the 400 gig upgrade cycle, 5G deployment, and enterprise multicloud initiatives each represent large opportunities where we are well-positioned to benefit over the next several years. Finally, we are taking actions to better monetize the value of our software, which should help us capture more recurring revenue and build on the success we've experienced over the last few quarters. Going forward, while we continue to sell hardware-based systems with a base level of software, we expect to increasingly look to monetize our more advanced software features through recurring licenses. We believe these efforts will not only prove beneficial for our customers but also create net new revenue for Juniper that will improve visibility, profitability, and customer retention. We believe we have the right systems and sales strategies in place to drive this transition that should benefit our software sales over the next few years. While the changes we are making will position Juniper to see sequential growth beyond the March quarter and a return to year-over-year growth at some point during the second half of 2019, some of these actions are likely to present near-term headwinds that we have factored into our Q1 outlook. We are also anticipating that the weakness we have been seeing in our cloud business continues through the March period. In addition, our Q1 forecast also factors in the potential to see below seasonal trends in our U.S. government business due to the recent shutdown of the U.S. Federal government which has historically accounted for about 15% of our enterprise revenue. Despite the potential to see near-term revenue headwinds, we remain focused on improving gross margin and optimizing our cost structure with the goal of positioning the business to see material earnings growth as the business recovers over time. In summary, while our business is lumpy and difficult to predict on a quarterly basis, we continue to believe in the long-term financial model we presented at our recent Analyst Day and remain optimistic regarding our long-term prospects. We are innovating in ways that truly matter to our customers, in which we believe should position the business to see improved long-term success. As evidence of the confidence we have in our business, we are increasing our quarterly dividend by $0.01 per share and we expect to initiate an approximately $300 million accelerated share repurchase program. I would like to extend my thanks to our customers, partners, and shareholders for their continued support and confidence in Juniper; I especially want to thank our employees for their hard work and dedication, which is essential to creating value for all of our stakeholders. I will now turn over the call to Ken who will discuss our quarterly financial results in more detail.

Thank you, Rami, and good afternoon everyone. I'll start by discussing our fourth quarter results, then cover the full fiscal year and end with some color on our outlook. Fourth quarter revenue of 1,181 million was below our guidance range, primarily due to the slower than anticipated pace of deployments with some of our cloud and service provider customers. Despite lower revenue, non-GAAP gross margin of 60.9% and non-GAAP earnings per share of $0.59 which was the high-end of our guidance range. Looking at revenue by vertical, Enterprise increased 14% year-over-year, driven by strength across all geographies and technologies. The 13% sequential increase in enterprise was better than normal seasonality and slightly above our expectations. Service provider revenue declined 15% year-over-year, primarily due to the weakness in Americas, partially offset by strength in EMEA. Sequentially, service provider declined 5% primarily due to weakness in the Americas and APAC. Cloud revenues declined 8% year-over-year and sequentially due to the pace of deployments. As Rami mentioned, we are confident in our position with our strategic cloud customers and that we are holding our footprint. However, the pace of deployments is proceeding more slowly than we previously expected. From a technology perspective, routing and switching businesses both declined year-over-year. Routing declines were largely due to the pace of deployments in service provider, which was partially offset by strength in enterprise. On a sequential basis, routing was down 10%, driven by service provider and to a lesser extent cloud, partially offset by an increase in enterprise. Switching declined 2% year-over-year, primarily due to the impact of the adoption of ASC 606, which was partially offset by the strength in enterprise. The 3% sequential growth was driven by enterprise and service provider, partially offset by a decline in cloud. Security was up 34% sequentially and 18% year-over-year. On a year-over-year basis, security saw strength in enterprise. Sequentially growth was driven across all verticals. Our Services business declined 1% year-over-year and increased 5% sequentially. The year-over-year decline was due to the adoption of ASC 606. Without the impact of ASC 606, Services would have increased 4% year-over-year. We are pleased with the performance of our software offerings, which were greater than 10% of total revenue in Q4. In reviewing our top 10 customers for the quarter, four were cloud, five were service providers, and one was in enterprise. Product deferred revenue was $144 million, a decline versus prior year. However, without the impact of the adoption of ASC 606, product deferred revenue would have increased 6% year-over-year. For the fourth quarter non-GAAP gross margin was 60.9%. Stronger-than-expected non-GAAP gross margin was primarily due to the increased software revenue and strong service margin offset by mix. Non-GAAP operating expenses declined 2% year-over-year and 3% sequentially. In the quarter, we had cash flow from operations of $212 million. We paid $62 million in dividends, reflecting a quarterly dividend of $0.18 per share. Moving onto the results for the full year, fiscal 2018 was a challenging year with revenue declining 8% and non-GAAP earnings per share declining 11%. The Enterprise vertical was an area of strength where we saw sustaining momentum growing 10% for the year. Security was another highlight for 2018, growing year-over-year for five consecutive quarters and posting 14% growth for the full year. Looking at our other technologies, routing declined 16% versus 2017, due to the ongoing architectural transitions in cloud and a deceleration in our service provider business. Switching declined 3%, primarily due to the weakness in cloud, which was partially offset by enterprise. Our Services business remains strong with 5% growth normalized for the adoption of ASC 606. The strength in this business was primarily driven by strong renewal and the tax rates of support contracts. Looking at revenue from a geographic perspective, EMEA grew 8% while the Americas declined 14% and Asia-Pac declined 8%. In reviewing our top 10 customers for the year, four were cloud, four were service providers and one was an enterprise. Total non-GAAP gross margin of 59.9% was a decline of 2 points year-over-year. In 2018, we continued to focus on prudent and disciplined operating expense management, resulting in a non-GAAP operating expense decline of 26 million or 1%. For the year, we had good cash flow from operations of $861 million. From the capital return perspective, we repurchased $750 million worth of shares and paid 249 million in dividends in 2018. Our total capital return for the year was nearly $1 billion and represented 140% of free cash flow. Before we move on to Q&A, I would like to provide some color on our guidance which you could find details in the CFO commentary available on our website. Our Q1 revenue outlook reflects continued weakness with our cloud customers. In addition, we are transitioning our go-to-market organization to enable our strategy. While we are confident these changes will lead to long-term growth, this may result in short-term challenges. We have also factored in the partial U.S. Federal government shutdown and geopolitical uncertainty which we believe could adversely impact our business in the early part of 2019. These factors lead us to expect below normal seasonality for the first quarter. Beyond the first quarter, we expect revenue to grow on a sequential basis with better trends during the second half of the year. A return to year-over-year growth is expected at some point in the second half of the year. We remain confident in our long-term financial model we outlined at our Investor Day in November last year. Gross margin on a non-GAAP basis is expected to be toward the low end of our long-term model in the first quarter due to lower revenue volume, product mix, and the impact of China tariffs. Full year non-GAAP gross margins are expected to improve directionally from Q1 '19 levels and we believe gross margin for the year will be toward the midpoint of our long-term model. Moving on to operating expenses, despite the reset of variable compensation and typical seasonal increase of fringe costs in the first quarter, we plan to manage our operating expenses prudently throughout the year. Based on our current forecast, we expect operating expenses on a full-year basis to be relatively flat versus 2018. For 2019, we expect a non-GAAP tax rate on worldwide earnings to be approximately flat versus 2018, plus or minus 1%. And we expect non-GAAP earnings per share of $1.75 to $1.85 for 2019. And finally, as Rami discussed previously, our Board of Directors have declared the increase of our quarterly cash dividend to $0.19 per share to be paid this quarter, to stockholders of record. This reflects an increase of approximately 6% compared to previous quarterly dividends. In addition, we plan to enter an accelerated share repurchase program of approximately $300 million. These activities reflect our confidence in the future prospects of the business. In closing, I would like to thank our team for their continued dedication and commitment to Juniper's success. Now, I would like to open the call for questions.

It sounds like you are pretty optimistic about the second half of 2019 and expect that you get to growth again. Just wondering if you could help us to understand or appreciate what opportunities you see as really the key drivers just things I'm thinking of whether it’s 400 gig or 5G opportunities or a snap back in the cloud demand? Could you maybe rank order what are the key drivers we should be paying attention to for that return to growth?

I'll take that. So, there are a few factors. First and foremost, as we mentioned within the cloud vertical, the MX to PTX transition is at this point largely behind us. And so while the pace of deployments in the cloud within the areas where we have strengths has been slower, we at least have reduced the impact of the product transition that was a big impact for us in 2018. Second, I would put the product roadmap. 2019 is a very big year for us from the standpoint of introducing new products across the board, especially in routing and switching. And yes, in particular for 400 gig but even in advance of 400 gig will be denser 100 gig products. Couple that with some of the optics innovations that we are going to be introducing to the market and we are going to have a very big year from the standpoint of just new innovation that we're putting into the market. Some of those happened this quarter, so our MX refresh, our MX5G refresh which gives us an opportunity to upgrade our very broad-based MX product portfolio with tens of thousands of chassis, hundreds of thousands of empty slots worldwide, gives us an opportunity to start selling and seeing a meaningful revenue contribution in the second half. The third factor that I would add would be just the sales changes that we are making. So as I mentioned in my prepared remarks, we are making changes that are somewhat challenging in the short-term, but I have complete conviction are the right changes for the Company in the longer term, and I do believe that we will start to see the benefits of those changes in the second half of the year. So that’s how I would stack rank or at least provide a color on the factors that give us confidence in the second half.

And Rami just to follow up on those comments. Is there any aspect of the weakness that you would attribute to the classic Osborne effect? Or are customers waiting for the new generation of products so buying fewer of the current offerings?

Simon, it's always difficult to predict how much that is a factor, but I would say thus far that has not been a big contribution to the impact. I think it's mostly the general weakness within the service provider vertical and the slowing of deployments in areas where we have strength within the cloud vertical. And on the cloud, I would say that the opportunity is still very much there to take net new footprints and that's what we are absolutely focused on right now.

Two-part question quickly. 5G and the drumbeat is on, I mean, we recovered names like keys and others. So, would it be second half Rami? Or when would be the timeframe when Juniper's starting portfolio would start inserting itself into 5G broadband? And then the second part of the question is approximately, would the second half also be the timeframe for any positive news on 400 gig cloud switching?

Let me address those in order. So first 5G, 5G I think does represent a meaningful opportunity for Juniper to see not just a recovery in our routing business, but honestly it takes share opportunity for us. That said I think it's going to be slow and steady. We are going to be running our business assuming that the challenges within the service provider vertical persist, but we are going to be preparing ourselves to capitalize on 5G opportunities as they become increasingly meaningful to our business. And to be more specific, first you mentioned routing, yes, I mean routing is a big area of innovation for 5G because 5G promises to put a lot more capacity in the networking demand and we are going to be prepared for that with our silicon and software roadmap to capture the opportunity. Secondarily security, you saw the strength that we experienced in our security vertical in our security technology in the Q4 timeframe. A big contributor to that strength has been in our high-end firewall technology that has seen its way into all the key segments but especially in service provider and especially to support mobile networks. And I think as the world moves to 5G the need to secure the infrastructure the data the users at scale without impacting performance only increases. And third is telco cloud. 5G is necessarily going to be a cloud needed technology. Many of the most strategic engagement that we have with our SP customers today are around the transition towards a telco cloud architecture. And I'm happy to report the win rate has been really, really encouraging. Across the globe we are now entering into more and more strategic build out of telco cloud opportunity that start with Contrail edge cloud as a software, but gives us the opportunity to up sell into switching routing security and our virtual services. It's not yet a meaningful revenue contributor, but I do think it starts to meaningfully contribute especially as 5G becomes more of a factor. On your question about 400 gig, I think the real revenue contribution for 400 gig will be next year in the 2020 timeframe, but the decisions or at least some of the decisions will start to be made in the third quarter in the cloud space and then followed shortly by the service provider space. So I think we are going to be well prepared with really fantastic technology and there is right timing for that technology this year to capture that opportunity across our entire routing and switching footprint and product line.

Rami, I think you made it clear that it’s a function of slowness and in demand in a part of carriers and the cloud. But I got to ask the question which is, is there any weakness due to competitive losses or due to place degradation and depending on connection with that slowness in demand?

Thank you, Paul. Yes, another one. In the cloud sector, the product transition is mostly behind us and is becoming less significant with each quarter. The new build outs are taking longer than we initially expected, but it's important to note that port growth is still occurring and at a meaningful rate. Based on our strong relationships with our cloud provider customers, I don't think we're losing market share; that's not the reason for our slowdown. It's really about our cloud provider customers utilizing the capacity they've already built into their networks and operating them more intensively before expanding. Overall, the cloud CapEx opportunity for us remains healthy. Our focus now needs to be on capturing new market share, especially as we move closer to the data center, where our presence among hyperscale cloud providers is still quite minimal. We've made significant progress with smaller cloud providers and enterprises, but we have yet to break into the hyperscale switching market, which is a major priority for us moving forward.

Yes, and just to add Paul, from an ASP perspective, we are seeing what I would refer to just kind of normal pricing decline on a per capacity basis. You know the big headwind of MX to PTX is behind as Rami mentioned are largely behind us. There is still going to be traditional routing pricing erosion that we are still seeing. And what's happening in the port growth although it's up, it's not enough to offset that kind of normal price curve. So port growth is up and that will be expected it to be and therefore the math has yet to turn to our favor on a real cloud routing.

So just some very quick clarifications, so normal pricing of the extraordinary. Rami in response to the question of cloud, I hear your response on the service provider things, you're down 15% year-over-year. Is that just softness in spend or you also going to pick up to some extent? And then Rami just to be clear in your statement about new products, the '19 is a really big year. Was '18 a relatively light year on your new product intros?

'19 relative to '18 is definitely a very different picture in terms of new product introductions. So '18, it was probably more of a normal year maybe a little bit light, '19 is a very different picture in terms of the sheer volume of product we will be introducing into the markets. Just to give you an idea four new custom silicon engines being their way into very different routing and switching product lines as well as merchant silicon offerings for the switching environment as well. And not to mention across the board in terms of our automation telemetry orchestration management software that we are going to continue to see substantial enhancements throughout the year. So 2019 is a very big year from a product standpoint. On the SP side, I think the market dynamics are just difficult within the service providers right now. As you know CapEx is sort of flattish, has been flattish for some period of time. I think many of the service providers are focusing on things like 5G ran on acquisition of content providers etc. etc. and we have to play that out. I do very much believe that we are maintaining the strong connections to our Tier 1 telco customer that we enjoy worldwide. And again in areas of future growth, especially in telco 5 transformation I think we are doing very well but just not enough to contribute and to offset the weakness in the more traditional areas.

Yes, we were expecting general pressure in service provider. We have experienced that for several quarters in a row. Down 15% year on year though that was not what we expected as we entered the quarter, nor do I think that’s the new normal going forward, that's really just customer concentration and lumpiness of the business. It really does fluctuate quarter to quarter but that’s not a trend that we expect to persist going forward at that level.

I have a question and a clarification. I think perhaps Rami my clarification is for you. I was wondering if you could help us eliminate what you meant when you said that the cloud target or targeted growth rates in cloud require some new wins for you to hit. And then my second question which is a bigger one is. The outlook that you shared with us at the Analyst Day in November I would guess didn’t anticipate necessarily a weak March quarter as what we were facing now. Could you talk us through about how things changed over the course of the second half of the quarter because it was quite a big shift?

Let me start on the question about the cloud maybe, Ken can address some of the questions about the outlook. So, the factors within the cloud vertical were one the product transition itself that we talked that linked about over a number of quarters now. And then last quarter we talked about some of the slowness that’s happening within the card vertical and investment in areas where we have strength. Assuming that that slowness continues, the pace of investments in the WAN area, the routing areas of the cloud market in particular the hyperscale cloud market persist, then yes, I think we will need net new footprint in order to achieve the growth that we outlined in our long-term model that we provided in our November analyst event. If for any reason the pace that which they are investing in the routing area picks up, then obviously that lessens the requirements on obtaining net new footprints. Either way, we are absolutely focused from a technology standpoint on winning net new footprints, and I'm confident that we can.

Yes, on the revenue side as we mentioned on the remarks and in the commentary we do expect sequential growth from here. I also highlighted that I expect the second half to be a stronger trend than the first half. And we expect to return to growth at some point in the second half. That said the EPS guidance that I put out there of a $1.75 to $1.85 does not depend on full year revenue growth this year. We are still striving for full year revenue growth but our EPS model does not depend on that. From a Q1 specific what is kind of changed, I would say the two things that what's calling out are obviously the federal government shutdown as we mentioned earlier, the sales disruption. So based on visibilities that I see now for Q1, I believe the Q1 guidance is very appropriate. I do believe some of the sales force options have been factored into that visibility and that should improve throughout the year. And we are still committed to long-term model I think that’s important to note.

This is Balaji on behalf of Rod. I think I wanted to go back to the routing and pretty clearly the PTX discussion a little bit more. When we were looking at the PTX transition a year ago, you had been considering a large increase in PTX ports to offset the ASP declines. And clearly, that's not what's happening at this moment. So I wanted to check how confident you are that kind of port growth can still happen in 2019 versus potential for any kind of displacement or share losses that you may have there? And then I have a quick follow-up.

So I have utmost confidence that the PTX product line is the right product line, especially for cloud routing buildups. And as I mentioned, the transition from MX to PTX happened for a reason and that is that the PTX was extremely well received by our largest hyperscale cloud providers. And I do think it's actually a unique platform in the industry in terms of robustness, physical scale, logical scale, programmability. All the things that are cloud customers truly care about. And the port growth within the PTX product line has actually been quite healthy. The factor that is impacting us today is simply the pace of which these build outs would with the PGF are happening, they are slower than what we had anticipated. And so even with more normalized pricing declines on a year-over-year basis, it just has not been enough to get us to growth. That's essentially what's happening with the product in that transition. But again, I just want to emphasize, I think the PTX is a wonderful product and it's extremely well received by all of our cloud customers.

And then on the go-to-market transition that you announced, could you just walk us through a little bit of the thinking there to how you got and came to the conclusion that it is the gap in the go-to-market approach that you need to change versus any kind of technological or partnerships that you may need otherwise?

Certainly, so, first the changes that we've made in go-to-market are changes that we have been thinking about now for several months and we've now put into effect. The first of which is around having a more segments-based model in go-to-market while we protect resources and we create more focus on success in each of our key verticals HP cloud and enterprise. But additionally, we've made some really tough decisions, but I think the right decisions in addressing benefit tool and minimizing the layers of the organization in making the overall go-to-market organization much more efficient. And even while preserving the investments in the quarter market our organizations, we have now increased the number of quota-carrying sales reps that will help us, especially in continuing the momentum or even accelerating the momentum that we've enjoyed in the enterprise vertical. None of these changes are easy, but I have utmost conviction that they are the right ones for the Company and they are going to pay off for us later this year. And I should just point out that Ken and I and Jeff are actually in Las Vegas right now at our global sales kickoff, where we have the opportunity to engage with our global sales and support organization. And I think people are feeling very good about the changes, even though they are disruptive and can be a little unsettling in the short-term. There is general consensus they are absolutely the right changes for the Company and people are quite optimistic that we can leverage these changes to achieve success and win.

A couple of vendors this earnings season have alluded to cloud demand being weaker. So, it’s true as how much visibility do you have into when cloud demand might get better?

We're not calling that right now. We are essentially seeing the slowdown in the routing market where we have the strength. But I do want to emphasize, when I look at the overall cloud opportunity. And yet we have real strength in the wider area in routing and DCI, data center interconnect, we have an incredible opportunity to move into net new footprint. And again, when we have a CTO, Bikash Koley that comes from that world that has been shaping our product strategy and our engagement strategy to attach towards that opportunity especially a 400 gig becomes a real momentum driver later this year. I think our ability to capture more of that share in the broader cloud opportunity is absolutely there.

And as a follow-up, any chance you will parse the delta in 1Q guidance versus expectations? Essentially, I'm wondering how much of that delta is from weaker cloud versus weaker federal versus all the go-to-market changes?

I won't provide specific numbers, but I can give you an idea of the order of magnitude. I would say cloud is the primary factor, reflecting a continuation of our Q4 results. The sequential decline from Q4 to Q1 is mainly due to our actions in Q4, particularly related to the cloud deployment base and some service providers. Next, I would identify the sales force disruption as another factor, and lastly, the U.S. government shutdown, although they are our largest enterprise customer, would rank third. We are working to address the 100 million gap.

I have a two-part question. So result from strength in the security and services segment and just two parts to this. The services revenue as a percentage of product revenue intensified to a pretty higher rate over 50% in 4Q 2018. What exactly is driving this? And then the second part is, on security you clearly have hit a new run rate of 100 million in the quarter. Should we expect this going forward through 2019 for each quarter? Or is this one-off in 4Q '18?

Let me start with the security question and then, Ken, why don’t you address the services piece. So first I have to say that I'm very pleased with the momentum that we've now seen in security for a number of quarters in the Q4 timeframe growing 34% sequentially and 18% year-over-year. What I like about the security number that we posted is broad-based momentum across cloud providers, service providers, and enterprises. We saw strong demand across the different lines of products in high end to mid-range and in the branch. And the diversity of use cases and just the number of net new million dollar deals all point to the fact that I think we can see continued momentum in security. Will every quarter be as strong this quarter? I think that’s an unrealistic expectation. So I think you are going to have some lumpiness and some moderation especially as now the comps become more difficult. But generally speaking, I think that we have cracked the recipe for success in security in terms of the strength of the product portfolio, but even more importantly in attaching security to our overall solution offering. So when we go to our customers and offer them a cloud data center solution, we know how to integrate security in that overall offering and I think that has worked quite well for us. Ken?

And from a services perspective, it was really due to the strength of our attaching renewal rates and I would call out that the majority of our services revenue is actually in that renewal category. It is product we sold over the last several years and we continue to service contracts. So, the correlation between current quarter product revenue and service revenue is really not that strong at all. The majority of the service revenue is prior period product sales and we continue to enjoy good renewal rates if we hold that revenue stream for us. I would add although it's still relatively small, we have seen a growth in our professional services business as well. And we obviously had a pretty strong quarter in Q4 in professional services.

And I just have one other question regarding Asia and EMEA. In Asia and EMEA we have seen clear indicators from Huawei and CTA and they are being replaced by alternative vendors across the equipment stack and we saw some of the industry data in 3Q 2018 point to this. Can you just give us an idea on Juniper's win rate for some of these open market share opportunities given that you are seeing U.S. vendors starting to win in those opportunities?

Yes, I think it's still too early to call any sort of the benefit from the new cycle and the concern around Huawei technology. However, having said that, I mean Juniper is a company that takes the security and the safety of our product extremely seriously and to the extent that more and more of our customers internationally put focus on these types of concerns and I do think it could present an opportunity that we will be capitalizing on. But at this point, we are still competing on the merits of our technology.

I guess I wanted to ask about the mix of port shipments into the cloud providers. On the routing side I think in the past, you talked about 80% being PTX versus MX. I guess I'm wondering what that percentage is now? And then also I just want to go back to the question of routing market share among cloud provider customers and I heard what you said about port growth coming out of those customers, but at the same time, those customers have been growing at tremendous rates and it's particularly if you look at their businesses from a revenue perspective. You're talking about them running their networks hotter. I guess I'm trying to understand where you're getting that point of view. Is that something that's coming in anecdotally? Or is just simply an observation based on ordering transiting in new business? Anymore flavor you could add around the demand trends there would be great in the market share?

I'll start with port count and then Rami can go on the last question. So from a port perspective, as we've been saying, there is like the MX to PTX largely behind as Q4 was another quarter of roughly 80%, 20%. So 80% of the products ports sold in Q4 were PTX ports 20% MX products. I do expect that percentage to still get move slightly up from 80%, but again it's low to the high end at this point and that's it's not going to go to zero. So we're finally settled to 80% to 15% maybe 90% to 10% part of the delta at this point but were mostly there at this time.

And I think, George, the part of your question is really around. Are we seeing competitive displacement? Or is it really just consumption of capacity that we're selling into the areas of the network within the cloud base that is traditionally very strong for us? And I can tell you just based on all the information we have and engagements we have this is not a matter of competitive displacement. We are as you might imagine working very closely with our key hyperscale customers in their network buildout and particular in the routing domains and the wider year domain. And we are fulfilling their capacity requirements and we see this and based on that engagement, but also based on the port growth that we are seeing and what we are selling. It's just a matter of the more normalized pricing compression that we're now seeing on a year-over-year basis, has not yet sort of outpaced if there is by the, it's not yet outpaced by the increase in capacity. As that plays out if the pace accelerates so I think we benefit from that and we do have an opportunity to capture net new footprints opening routing areas where we don't yet have presence as well as especially internationally, as well as in the switching domain.

I'm sorry, James, maybe mute by accident. And we will go to the next question here from Ryan McGregor from Wolfe Research. Please go ahead.

This is Ryan on behalf of Steve Milunovich, just a quick question for me. Going back to EMEA, the region continues to show strong growth. Could you guys talk about what's driving that and what might be working in that that maybe could translate back to APAC or the Americas?

Certainly, yes, so we are pleased with our momentum in the EMEA region growing 6% year-over-year. It's actually broad-based so the strength is across enterprise and service providers cloud as well as cloud is less of a factor in the EMEA region. It's also we are seeing strength across all technologies areas routing and switching. I think it really comes down to strong sales execution in that region. In fact, our new sales leader, Marcus Jewell, for a global sales organization was running in the EMEA region until he was promoted to that role. And I do think that one thing that we have done very effectively in the EMEA region is to sale the broad strength of our solutions. So when I talk about our telco cloud transformation or Contrail Enterprise Multicloud to help in multicloud connectivity for the enterprise domain, EMEA has led the way and demonstrating what's possible by up selling into these solutions, and I think they have benefited from that. The key now, especially with some of these go-to-market changes that we have put in place is to replicate that model that has proven itself to be successful need in that region across the world.

And then just one follow-up in terms of software revenue as a percent of total revenue, so it's been about 10% for two quarters in a row now. Last quarter when it was about 10 you guys guided down, saying it probably would maintain that level, but it's about 10 again, but you are guiding down again. So just curious what your thought process is around that?

Yes, so last quarter was approximately 10; this quarter actually crossed 10 for the first time. And based on the deals that we see and visibility we have, I do think it's going to modulate plus or minus a bit off of that category. I'm not expecting a material drop down to something 7 to 5 or anything that nature, but I do think 10% that we crossed in Q4 is not repeatable in the first half of next year. But directionally over the next several years, I'm quite confident that software as a percent for total revenue will only go up and exactly put a long-term model out there of greater than 15% by 2021. So, we are well on track to achieve that on a full-year basis while getting fluctuate a bit quarter-to-quarter.

And just some additional commentary on that, this is a matter of strategy. We have been really focused on increasing our software as a percentage of total product revenue in total revenue. We have now implemented a pricing model and a business model first to offer across all of our product lines that have been well received by our customers. We are introducing new software capabilities and software products into the markets especially our Contrail suite of products that have been very well received by our customers and we are seeing the momentum there. So, I do think that over time on a long-term basis, we are going to see software become much more meaningful. I think that’s good for our customers. I think that’s good for Juniper. So even if it fluctuates, I think thus far we are very pleased with the results that we've been able to achieve.

Operator, we have time for two more questions.

Just wanted to touch base on the security side of things. Good quarter there kind of going off to another question with the strong growth, and Rami you are saying that you don't think it's sustainable. I guess how should we think about the competitive nature for the high-end firewall refresh especially as you've had a competitor now come out with a targeted service fiber firewall?

The security market has always been highly competitive, and our approach has involved developing a technological edge along with effective solutions and market strategies. From a technology perspective, our strength lies in the combination of feature richness, scale, and performance, which we've seen in our high-end firewall offerings. We did experience some challenges in security about a year ago, primarily because the high-end refresh took longer than expected. Once we recognized the need for this refresh, we ramped up our efforts, and we became confident that it would differentiate us in the market, which it has. Moreover, we have integrated security into all our solutions, specifically in multi-cloud offerings that help customers manage assets across both private and public clouds. This integration has provided a compelling reason for customers to choose our security solutions. Overall, it appears our strategy is effective, although I do not believe an 18% sustained growth rate is realistic. However, I do see continued momentum ahead.

And then just two quick housekeeping items, you guys kind of started breaking out Contrails and software in terms of growth, I guess, how big is Contrails now within the software business today? And then secondly, did you guys give a weight Q4 from the tariffs on in terms of lift on revenue, and if so can you quantify it?

Yes, so Contrail is relatively small. We're not going to breakout the total dollars. I would say that the primary value that as we've been talking about for quite some time is not just the monetization of Contrail, but the actual discussion around the customers and architectures that were promoting with Contrail and the strategic nature of the sale. So, we're not going to breakout the numbers, but it is growing by itself, but it's actually alignment to win large opportunities in both service provider and enterprise and that's really a biggest impact to our numbers. On a tariff perspective, I will say from a gross margin perspective, it had about a 30 basis point impact to the Q4 gross margin. I've also factored a similar level into the Q1 gross margin. From a revenue perspective, again, it's difficult to quantify whether any pull ends because of potentially concerns of higher tariffs. I do not believe we have a material revenue change because of tariff. I think it was pretty much normal course and speed in Q4. At this point, I'm expecting similar in Q1. I'm not expecting anything impacted by tariffs on the top line.

This is Samik. I have two questions. The first is about the award win in Japan with the broadband tower. I'm interested in what influenced the customer's choice to select Juniper and whether other competitors were considered. I also have a quick follow-up after that.

Yes, so we are very pleased with that award. I think it's just one of many that we would see with net new logos in the quarter. I believe that was more of a routing opportunity but one that we are very proud of. Beyond that, I think as we highlighted in the press release.

And then my second question is just on the recent agreement with IBM. I'm just curious that we should be thinking about any synergies there whether that would be cost or revenue from consolidating that outsourcing partner?

Yes.

And the primary thing you should see there is actually some efficiencies on cost side that source of large part of our IT organization to IBM. It should enable efficiencies due to their scale and automation that they built over years. So we are very excited about the opportunity to keep our service levels high for our customers and our IT service levels high but actually get a benefit on the cost side over the term of the IBM contract.

Thank you everyone for your questions. We look forward to speaking and meeting with you over the next couple of months.