Jess Lubert - IR Rami Rahim - CEO Ken Miller - CFO

Jeff Kvaal - Nomura Instinet Vijay Bhagavath - Deutsche Bank Simon Leopold - Raymond James Paul Silverstein - Cowen & Company Ittai Kidron - Oppenheimer Tal Liani - Bank of America Merrill Lynch Tejas Venkatesh - UBS Sami Badri - Credit Suisse Samik Chatterjee - JPMorgan Aaron Rakers - Wells Fargo Jamie Fish - Piper Jaffray

Greetings and welcome to the Juniper Networks Third Quarter 2018 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Jess Lubert. Thank you. You may begin.

Thank you, operator. Good afternoon, and welcome to our third 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 discussions 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 Q3 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 turn the call over to Rami.

Thank you. Good afternoon, everyone. We reported better than expected results during the September quarter. Total revenues of 1.180 million was above the midpoint of our guidance, as continued strength in our enterprise business along with better than expected service provider sales more than offset weakness within the cloud. In addition, gross margin exceeded the high end of our guidance, while operating expenses came in towards the low end of our forecast, resulting in non-GAAP EPS of $0.54, $0.07 above the high end of our outlook. We're seeing encouraging development in many areas of our business, which are providing confidence in our long term growth prospects. Some of these developments include the following. Our enterprise business continues to see solid momentum, rising 15% year-over-year and growing year-over-year for the seventh consecutive quarter. Strength was experienced across all technologies and we benefited from a diverse base of customers. While our enterprise switching and security business both grew year-over-year, we also saw very strong demand for our enterprise routing portfolio, as new solutions such as the MX204 and the MX10003 are seeing solid success in areas of the market where we previously didn't play. We believe we have the right products and strategy to win in the enterprise markets and we are strengthening our go to market focus on this vertical, under our new Chief Customer Officer, Pierre-Paul Allard. Security was another bright spot in Q3, growing 8% year-over-year and rising for a fourth consecutive quarter. While our breadth of security deals was strong in the period, we were also encouraged to see an uptick in the number of transactions over $1 million. We experienced strong security booking during the September quarter and we remain optimistic, regarding the growth prospects for our security business. While our service provider revenue declined 6% year-over-year, the business grew 4% sequentially and performed better than we expected. We believe the upside relative to our expectations reflects the strengthening of our relationships with many of our top service provider customers who recognize the value of the innovations we're bringing to market. We believe our orchestration telemetry, node slicing cups and universal chassis capabilities are leading the industry and should position us to win with our service provider customers. We are also optimistic regarding the potential of our MX5G offerings, which we spec to begin shipping early next year. We believe customers are increasingly recognizing the value that Juniper is offering. We believe this was highlighted at our recent NXTWORK’s user conference, where customer and partner attendance more than doubled year-over-year. We’re excited about new and expanding partnerships with firms like Nutanix and Ericsson, which we expect to not only strengthen our ability to capitalize on multi-cloud and 5G initiatives, but also broaden our reach and drive competitive advantage versus alternative offerings. We're also in the early stages of ramping several important new innovations, such as Contrail Enterprise Multicloud and the SPC3 line cards for our high end SRX firewall, both of which began shipping in the third quarter. These platforms bring material differentiation to the market and are already seeing strong customer traction, which should prove accretive to growth in future quarters. Not to be overlooked, we're on the verge of introducing the industry's first 400-gig product and believe we will be well positioned to gain share, as cloud, service provider and enterprise customers look to meet surging bandwidth requirements. Our software business had another strong quarter, rising both quarter-over-quarter and year-over-year and accounting for nearly 10% of our revenue. While this strength was due to several one-time license buys and we do not expect our software business to remain at this level over the next few quarters, we continue to introduce new software solutions to the market and are putting go to market strategies in place in order to drive higher software attach rates in future periods. While we remain optimistic regarding our long term prospects, we are also seeing some challenges in the market, particularly within the cloud vertical where we believe several of our customers are running their networks harder and the pace of deployments are proceeding more slowly than we previously anticipated. Based on our current forecast, we're not expecting a material improvement in cloud revenue during the December quarter, which is the primary reason the midpoint of our revenue forecast no longer embed a return to year-over-year growth in Q4. This weakness relative to our prior forecast is mostly due to our expectations regarding the impact of cloud driving sales and to a lesser extent cloud switching revenue. Although the timing and pace of cloud deployments remains difficult to predict, we maintain a high level of engagement with these important customers and remain confident we are not only holding our cloud footprint, but also positioning to benefit as incremental capacity requirements eventually drive improved demand. As we announced earlier in the quarter, Pierre-Paul Allard joined us as our new Chief Customer Officer. I'm excited to have him on my team and believe the changes we will make under Pierre-Paul’s leadership will help further drive improved sales execution. In summary, while our business is lumpy and sometimes difficult to predict on a quarterly basis, we remain confident regarding our pipeline of opportunities and our ability to grow the business in 2019. Perhaps, more importantly, we are innovating in ways, which truly matter to our customers and should position the business to see improved long term success. 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 the call over to Ken who will discuss our quarterly financial results in more detail.

Thank you, Rami and good afternoon, everyone. The results for the third quarter were better than expected with revenue of $1.180 million, above the midpoint of our guidance. Non-GAAP gross margin of 61.1% and non-GAAP earnings per share of $0.54 were both above our guidance range. Our enterprise vertical posted its seventh consecutive quarter of year-over-year growth, increasing 15%, driven by strength across all technologies. The 4% sequential decline was consistent with normal seasonality and in line with our expectations. The service provider vertical declined 6% year-over-year, but increased 4% sequentially. The sequential growth was better than expected, primarily due to strength in EMEA. Cloud revenues declined 28% year-over-year and 11% sequentially. The declines reflect a slower than expected pace of deployments. As Rami mentioned, we remain confident in opposition with our strategic cloud customers, however, the pace of deployments is difficult to predict. During the quarter, routing saw 15% decline year-over-year, primarily due to cloud, partially offset by strength in Enterprise. Our switching business grew 4% year-over-year, primarily driven by the impact of the adoption of ASC 606. Security posted a fourth consecutive quarter of year-over-year growth, increasing 8% and the growth was driven by strength in all verticals. Our services business declined 1% year-over-year, due to the impact of the adoption of ASC 606. Without the impact of ASC 606, services would have increased approximately 6% year-over-year. In reviewing our top ten customers for the quarter, five were cloud, four were service provider and one was an Enterprise. Product deferred revenue declined in the third quarter, primarily due to the adoption of ASC 606. Without the impact of ASC 606, product deferred revenue would have increased 1% year-over-year. For the quarter, non-GAAP gross margin was 61.1%. The sequential improvement was primarily driven by favorable product mix, including the positive effect of higher software sales and geographic mix. Non-GAAP operating expenses were flat year-over-year and declined 1% sequentially. Cash flow from operations was $207 million for the quarter, an increase of 6 million year-over-year and $37 million quarter-over-quarter. The sequential increase was primarily due to lower tax payments. Our $750 million ASR, which was initiated in Q1 of this year concluded in the third quarter, resulting in the retirement of an additional 6 million shares in the third quarter. We also paid $62 million in dividends in the third quarter. Our total cash, cash equivalents and investment balance at the end of September quarter was $3.6 billion, a modest increase versus last quarter. Before we move on to the question-and-answer part of the call, I would like to provide some color on our guidance, which you can find details in the CFO commentary available on our Investor Relations website. While we were expecting to return to year-over-year revenue growth in the fourth quarter, the midpoint of our guidance reflects a year-over-year decline. This is due to the slower pace of expected deployments from cloud customers. In addition, while the recently implemented China tariffs are not expected to have a material direct impact on our Q4 ‘18 financial results, customer buying behavior could be affected and gross margin may be slightly impacted. While we expect to see gross margin benefit from volume in the fourth quarter, our guidance is down sequentially due to a more normalized product and geographic mix. We expect full year non-GAAP operating expenses to slightly decline on a year-over-year basis. It's also worth noting that the higher interest rates, other income and expense is likely to be lower going forward, in line with our Q3 ’18 results. While we expect our Q4 ’18 non-GAAP tax rate to be approximately 18%, we believe our go forward non-GAAP tax rate will be approximately 19% to 20%. In closing, I would like to thank our team for their continued dedication and commitment to Juniper’s success. Now, I'd like to open the call for questions.

[Operator Instructions] Our first question is from Jeff Kvaal from Nomura Instinet.

Yes. Thank you very much, gentlemen and two questions for me. I guess number one, could we start on your visibility on the cloud. What can you tell us about the projects and what have you in the past? You've been able to look a little bit further out there one quarter. Perhaps, you can help us understand where the PTX migration is. And when we might be able to expect an uptick? And then secondly, if you could give us a little bit of visibility into the 400-gig cycle and what -- how you expect that to play out for you through 2019? Thank you.

Thank you, Jeff. This is Rami. I'll start with your questions. And the first one on the cloud, clearly, the timing of project build outs have been difficult to predict. I just point out that it really is tied to a very few number of cloud providers, so you only have to get it wrong for a couple of customers to get it wrong all up. Having said all that, I still maintain that we have all of the ingredients in line to get this part of our business back to growth, from a technology standpoint, talent standpoint, the engagement at the engineer level within our organization that's all working very well. So I do think 2019 all up will be a growth year for us in the cloud based on the visibility that we have, the timing of deployments. To your question around the product set, all or most of the big product projects that we are or projects that we're working on right now that should see deployment in the coming quarters are PTX based. So I don't think that there is any difference based on what we've articulated in the past from a product standpoint. And tied to that is 400-gig. So very importantly, if you look at our cloud provider strategy all up, one element of the strategy is to ensure that we're doing everything that's necessary to maintain our footprint where we already have incumbency and of course that's a large footprint that exists among the major cloud providers. And to return that part of the business to growth as the capacity requirements dictates or requires more networking capacity throughout their networks. But beyond that, there is a deliberate strategy to move into new footprint, especially closer to and into the data center with our switching portfolio. And honestly based on everything that we are working on from a software standpoint, from a silicon technology standpoint as well as the 400-gig roadmap, we have a lot of confidence that we can in fact expand our footprint. The last point I'll make around the cloud provider space, because I know it is top of mind for many of you is just that, we look closely at the health of the market from the standpoint of the health of our customers’ businesses, right, the businesses of our cloud providers is thriving and we don't anticipate any major slowdown from that front and that should only maintain the requirement for them to invest in their network, so I remain optimistic about this part of our business in the future.

It's a little difficult for us to square the growth in those businesses with your down cloud revenues, Rami and I think that's what has us scratching our heads a little.

I totally understand that, but it's actually not that confusing when you think about it, because the major element of the revenue shortfall is the product transition. We’re moving from a product that has a certain price per port to a different product that has a lower and substantially we’ve been open with you about this, they’re substantially lower price per port. We did this deliberately to avoid a scenario where we find that we will lose footprint, if we don't. So we are, in effect, disrupting ourselves to make it much more difficult for anybody else to come in and to disrupt us. So while, yes, it will be painful and dilutive to revenue in the short term, I think it's exactly the thing that we must do today to preserve that footprint and to get back to growth in the coming quarters. So I think that's the biggest element of the downturn in revenue that you're seeing today.

And the only thing I would add, this is Ken, is that our actual port count has grown here to date FY18 as compared to this point last year. So we are seeing growth and volume growth in port count and we're also seeing stabilization in pricing per port. So, as we continue to see growth, we will start to see revenue come back to growth as well as our expectation.

Our next question is from Vijay Bhagavath from Deutsche Bank.

Two questions if I may quickly, Rami and Ken. The first is the delays in the cloud customers. How did that get you caught by surprise, because the delays or the slowdowns were generally known? And then the second part of the question is, the 5G cycle is starting to crank up here with Verizon in particular, when would you see kind of any order uptake in the routing business, as 5G broadband starts getting commercially deployed? Thanks.

Thank you, Vijay. Again, I want to sort of emphasize the fact that the timing of projects within the major cloud providers is really tied to a very few number of customers. And so if you get it wrong for just those customers, then obviously that puts challenges all up. Now, the guidance that we provided for Q4 is not that different than what it had was originally, so I don't think that there is a massive change in our outlook, relative to where we were just a quarter ago. And again, I want to emphasize the fact that I think we're doing everything necessary across the board to ensure that we are there to take advantage of the build outs when they occur and I do believe that they will occur based on our very tight engagement and conversations that we're having with our cloud customers. Second is your question about 5G. I'm very excited about the opportunity that 5G presents. I think the only question mark around 5G is really around the timing of those opportunities. Yes. I think you're starting to see some news and some very early deployments for 5G and in particular in the rand space, but we're gearing up across the board with our technology, so the MX5G capabilities that come in to the market in the Q1 timeframe with a feature set, it's really honed towards 5G option. Our partnerships with companies like Ericsson that I think helps us in relevance in penetration, in accounts where our customers are clearly thinking about their 5G roadmaps and then last but not least is the fact that most of the 5G deployments are really going to be cloud native in nature and we're seeing a really solid win rate right now in our telco cloud solution that includes Contrail as an SDN controller as well as the underlying switching, routing and security infrastructure to support that telco cloud architecture and this is being done -- basically rolled out by our customers in anticipation of 5G. So we're not waiting until 5G becomes a big spend cycle before we start to take advantage of the opportunities that are out there.

Our next question is from Simon Leopold from Raymond James.

This is Victor Chiu in for Simon Leopold. I know you said that the tariffs weren't expected to be -- to have too much of a material impact in the fourth quarter, but can you tell us -- can you help us understand what’s the expected effect of the tariffs, assuming the step up to 25% in January.

Sure. So, this is Ken. So, clearly, we're watching it closely and we're not -- our position is not unique here. All of us are watching intently. Our strategy is to mitigate the impact of tariffs as much as we can. We have a global footprint. We do manufacture in multiple places, including China. There will be an impact. We were not able to mitigate and our current strategy is to pass an impact along to our customers and partners in the form of an import tax charge. Presuming we're successful in doing that would be largely profit neutral gross margin, sorry gross profit neutral, but it does have the potential to have a negative impact to gross margin as we move forward. Clearly, as we move to 25% or the potential to go to 25% would have a much more significant impact than the current tariffs. We're watching closely and we'll look to mitigate as we can going forward.

Do you have a sense of how successful you may be in passing those or having customers absorb the increases?

Yeah. It's early days right now, but at this point, we feel pretty good about our position with the Q4 tariff in place and our ability to not only mitigate, but also pass along a relatively small increase to our customers.

And given that this is an impact that’s kind of across the board, are there competitive implications here for Juniper or.

We're watching the industry close. Clearly, in our case, it is important to note that all products are impacted, right. We do have many products that are not impacted. So mix is going to also matter as a result – as the impact of the tariff to the P&L, looking to optimize our footprint to put more in the non-tariff locations is something we're looking at very closely as well and we will continue to remain competitive in the marketplace.

Our next question is from Paul Silverstein from Cowen & Company.

A couple of clarifications and a question. And the clarification is, Ken, I think I heard you say pretty clearly that pricing normalized on a year-over-year basis, on a like-for-like per port basis. I just want to confirm that. I recognize you had a big reset with the cloud situation, but is pricing now is ready to kind of normalize? And --

Yes. I'll just jump in. Yes. That is correct.

And I assume, you're trying to exposure to just both direct and indirect with the indirect piece being by virtue of suppliers that it is just contract manufacturers or purchase components and their self-assemblies and I assume before we’re going through that quantification, I'm hoping you give us some sense for what both the direct and the indirect exposure is and then the real question, from a competitive landscape standpoint, with the understand that revenues are backward looking, so I'm asking I'm looking out into the future, are you seeing any impact at this point from Cisco or Nokia, which both have introduced new platforms relatively recently, Arista, which has come in to the market as well with their own routing stacks, are you seeing them impact either your win rate in terms of new projects that haven't shown up in revenue yet and/or pricing.

Let me take the competitive question. I -- honestly I haven't been this confident and optimistic about our technology roadmap ever at Juniper. If I look across the board from our switching portfolio, our routing portfolio and our security portfolio, I look at the underlying technology elements from a silicon development standpoint, our silicon photonics efforts, our operating system developments that we are making on, on an ongoing basis. And then the systems that we're introducing into the market just over the next year that are going to be 400-gig capable that are going to have operating system capabilities that are absolutely aligned with the direction of the market, I think we are going to be extremely competitive and I think we're also adding to that new layers of innovation in particular around the enterprise where our Contrail Enterprise Multicloud solution is really resonating with many of our enterprise customers that are looking to move to Multicloud solutions that I think is giving us a real leg up right now in the marketplace. So if anything, my expectation is that as we continue to introduce these systems, the software capabilities, our win rate will only increase going into next year.

Rami, do you think you can convert, there's obviously been secular issues on top of the competitive landscape in these service provider routing markets, do you think that can return to growth, are you going to have the benefit of using comps that are getting into, again, I understand there are secular challenges, but is it your internal expectation that that will return to growth or at least stabilize.

So, in our November Analyst Day, we'll provide you with a longer term outlook for our business across each of our key market verticals. In the SP space, what I'll tell you for now is we're not going to model into our outlook a return to growth next year. We're going to be prudent and careful in our expectation for this SP-based, primarily because of the secular issues that you're talking about. Having said that, there are a number of opportunities that are out there, that we are out to capture. These are net new footprint type opportunity for us in the demand of telco cloud in preparation for 5G deployments. In the cable space, remote fi type architectural solutions, metro build outs in anticipation of increased capacity requirements for 5G deployments, all of these are examples of net new opportunities that we're going after. The last one I will mention that we're actually already seeing really meaningful progress in is in our smaller form factor MX solutions that 204 and the 10003 that are already bringing us into footprints and new tier 2 type service providers that we never had a shot at in the past. So, there's a lot from a opportunity standpoint that I'm optimistic about, but I'm -- I also just want to be cautious because of the all up secular issues in our outlook for next year.

Yeah. And on the tariff front, I'm not going to break out the direct versus indirect. I will tell you that the majority of our exposure is on the direct side. Just to give you some numbers, I mean, for the balance of this year, we expect the import tax charge to be 3.5% of the net invoice for those impacted skews. So again not all skews are impacted, but for those impacted skews selling into the US from China, there will be an uplift on invoice of 3.5%. At that level, it should have a negative impact to gross margin of about 20 to 30 basis points, but it should be relatively profit neutral and clearly the exposure would go up, if the tariff did increase next year.

Our next question is from Ittai Kidron from Oppenheimer.

Let's talk about some of the things that work like enterprise and security. Maybe you could talk about, Rami, about the pipeline activity. I guess the one thing that people will be concerned about that is finally the time when cloud recovers, those things start slowing down. So help me think about the business momentum that you have there, how does the pipeline look like and how do you separate just the general strong spending environment from your performance, how do you tell how much of it is just all lifted versus you're delivering something that others do not.

So I'm honestly very pleased with our performance in the enterprise space all up and in security. There is definitely a robust spending environment in the enterprise globally that we're taking advantage of, but we're now seeing seven consecutive quarters of year-over-year growth in the enterprise, the last quarter in Q3, 15% year-over-year. So I think that this is a emotion that's really working for us, a focus area that I'm quite optimistic about. To double click on it, we're seeing strength in customers that truly value and view their networks as mission critical to their businesses. So in the federal space, financial services, large banks, the momentum there is very strong. We're delivering solutions that are very meaningful for the direction of travel of many of the CIOs within those customers. Everybody today is thinking about how to move a Multicloud architecture. Few have the tools and the capabilities to do it. So in our view, this is an unsolved problem that is ripe for us to jump in and to help them solve it and our enterprise Multicloud solutions are doing just that. We have gotten third party validation from analyst firms like Gartner and Forrester recently about our data center networking technology and software defined networking capabilities that our enterprise customers pay very close attention to. And then of course, there is the sales motion. There is some solid sales execution that is happening in the enterprise due to a focus on going after net new logos and I expect that to only improve with the sales leadership changes that we have made in the company, primarily with the welcoming of Pierre-Paul to the company. So when I – and may be the last point on the enterprise, the enterprise routing, it's not just about switching and security, enterprise routing with our newer products or newer innovations like the 204 to 10003 are really working for us and enabling us to capture new footprint that we have not done in the past. So I expect that momentum to continue because bookings are solid, the engagement level is great and the execution all up I believe will only improve from here. Now going into security, in the security space, we had mentioned in last quarter that we had refreshed practically our entire product line with the exception of the high end, which was due for a refresh and that refresh happened in the Q3 timeframe with the third generation of our SBC line card for our high end firewall and as expected, the uptake and the pipeline built immediately again in a number of different customer verticals, in particular, in the banking sector, where that kind of security performance is just mandatory and honestly, they can't get from anybody else out there. And so we benefited from that in Q3, not just from a revenue standpoint, but from a booking standpoint, which will help us in future quarters. So both from an enterprise and security standpoint, I'm quite optimistic looking forward.

Yeah. The only thing I would add is just the breadth of the string. So for security, it was -- all verticals were up, both service provider cloud and enterprise. For enterprise, all technologies were up, routing, switching and security, so that breadth is very encouraging. I would also add that for both enterprise and security, our number of million dollar customers were up in the quarter. So we’re seeing it kind of a broad based growth across the board for those two parts of our business.

Our next question is form Tal Liani from Bank of America Merrill Lynch.

Hi. I'm trying to go back to the cloud question, and I'm trying to understand two things. First going into this quarter, we started hearing that few big cloud vendors, hyperscalers are reducing spending, because they started the year very, very strong with spending, and it's concentrated, but if you aggregate the numbers are so big, if you aggregate, you still see a decline in second half versus first half. So that's one driver, which is weak spending possibly. The second driver is that you've been working on architectural changes at some of your biggest customers, and the PTX was entering this quarter, the migration was 80% done, you said it in the past. And also at the switching level, the migration was happening, and I'm trying to understand what's the source for the weakness in cloud, is it because there is no spending and there is pressure on spending by cloud vendors, or is it because some of the components of your technology changes, some of this is not working according to the timetable that we expected or so is it technology or is it spending? Thanks.

Thanks for the question, Tal. So I'll answer it in reverse order. I don't think it's a technology issue. The PTX, the product that we build, the technology, the feature capabilities were all developed exactly to capture the future cloud opportunity and our view has not changed at all in terms of the strength of that platform for those use case and those deployments. From a spending standpoint, I mean, we look at the same CapEx reports for the cloud providers that you do and obviously these are all encompassing CapEx reports that capture all of their investments across many different technology areas. And yes, there could be shifts and priorities for some of the largest cloud providers in terms of where they're going to be focusing their investment in different layers of the network or between different areas of IT that can impact the timing of deployments, and I suspect that is a function of what we're seeing out in the market. This is why, I don't just look at the CapEx reports, I also look at just the overall health of their own businesses, and I mean they're going to report soon. I don't expect any major slowdown. I expect that they are going to see robust business growth for them, and that is going to translate into a need to continue to invest into their networking infrastructure. We obviously can't predict the timing of build outs perfectly. Sometimes, they themselves can't predict their own timing, which makes it especially challenging for us. But what we can do is control everything that we can control in order to ensure that we capture the uptick in spending when it actually happen and there is the technology element to that, the talent element to that and the engagement element to that, that I've already talked to.

If I measure your performance in terms of units, ports and I apologize, I missed the first two questions. So maybe you answered this, but if I measure your performance with cloud in different ways, not in dollars, but rather ports, units, any other way. Will you have the same answer and I'm asking the question just because there is a pricing difference between PTX and MX and per ports. I'm trying to understand if what we're seeing is more of a pricing transition or what we're seeing is really overall kind of big picture spending pressure?

I would say that the port or the number of ports or this volume of capacity that we have shipped into the cloud vertical this year has already far exceeded what it was year-to-date last year. So, I mean and port spending and consumption will fluctuate on a quarter-over-quarter basis, so it's actually more instructive to look at this on a yearly basis, but what we're seeing is, it's much more a function of price per port at least as it pertains to Juniper and our own projects, then it is volume of ports that we're actually shipping to the cloud providers. And again this since it's actually a good question that you're asking here. At the November analyst day conference, I think we can provide you with some more data that would give you the, what you're looking for in terms of actual port and capacity introduction into their networks.

Our next question is from Tejas Venkatesh from UBS.

Thank you. I’m on for John Roy. Following on from the previous question, I was wondering how 100-gig pricing for routing was in the quarter. You had indicated stability in the prior quarter. Is that still the case?

Yeah. Our pricing has been very consistent from a like to like perspective, whether it be 100-gig to 100-gig or PTX to PTX. So we are seeing that normalize within the cloud routing as well as the SP routing. In fact, from a cloud all up routing perspective, we saw the ASP go up per port because we didn't see as much PTX mix as we expected to see as we enter the quarter, but on a like-for-like, it was very, very stable.

Thank you. And a long-term question as a follow-up, you've made a number of announcements around network automation and Contrail in recent months. Is there a way of thinking about how much incremental TAM this brings to Juniper and perhaps the industry?

Yeah, it's a good question. In some sense, it does introduce new TAM because there is in fact a certain amount of spend that goes into automation and orchestration across a number of different use cases, whether it be in telco cloud or in multi-cloud for the enterprises and so on. It's a TAM that’s measured in billions, it's something that we can’t provide you with some more specifics around. It's not a small TAM, but that's only part of the strategy. Capturing that software investment as net new revenue for Juniper is something that we, of course, intend to do, but what we're also seeing, which is equally important to us is the fact that the software, the automation capabilities that we're introducing into the market are giving us an ability to sell holistic solutions. So for a Tier 1 telecom operator in Europe, we are essentially providing a complete stack from the server compute storage up through orchestration and VNF, the Virtual Network Functions, all up as a solution. There is the software and the hardware element to that sale. Increasingly in the enterprise space, as we're selling Contrail, whether it's immediate or eventually over time, Contrail Enterprise Multicloud becomes a strategic control point that allows us to sell additional infrastructure like switching and like security and like routing in time and we're already seeing that play out. Contrail Enterprise Multicloud has only been shipping now for a few weeks. We already have our first few wins that validate that solution sales thesis that I just described and this is why we are so optimistic about these capabilities that we're introducing to the market.

Our next question is from Sami Badri from Credit Suisse.

Hi, thank you for the question. I wanted to touch on the cloud deals very quickly and regarding them getting pushed out. I wanted to get more color on what type of cloud deals these actually are and more specifically, are these the very major 100 megawatt datacenter facilities that our cloud providers building or are they more Metro dense sites that aggregate significant traffic on the routing level. I just want to get an understanding on where exactly in the cloud supply chain this stall and deployments is occurring?

It's most -- the way I would characterize it is, it is the pace at which deployments are happening. And this is -- this touches the footprint that we have already deployed across the cloud space, which is in the wide area. So, data center interconnect backbone, it's -- these are real routing footprints that carry large volumes of traffic between data centers and connect the data centers to peering points that varies from cloud provider to cloud provider, but generally speaking, we're talking about wide area connectivity.

And then those are predominantly PTX deployments not MX or historically MX was used, but now moving forward, using mainly PTX?

That is the nature of the transition. Yes. So historically, they've primarily been MX-based and going forward, they will mostly be PTX based. There will still be even within the cloud vertical, some use cases that rely on the programmability, the sophisticated feature set of the MX, but most of the major projects and certainly the projects that we're monitoring closely in terms of pace of deployments is -- are all around PTX.

And the second question I had was more of a big picture regarding 5G, based on your conversations with customers or the expectations of demand for 5G deployments, which products do you see customers deploying first from your suite of systems? And are there products that may they may potentially move away from, given the type of infrastructure they're looking to scale up as 5G ramps?

Yeah. It's another good question. It really depends a lot on use case and we view it as follows. There is a very big telco cloud solution that involves our switching technology as well as Contrail Enterprise Multicloud and our own network functions like security network functions as well as third-party network functions that all stitched together in preparation for 5G. In the backbone, it's a combination of MX and PTX. In the Metro, it's mostly MX and ACX. And so the product that will depend very much on the particular use case that you are talking about. I will also just mention here that we're working very closely with our partners to capture the 5G opportunity. Ericsson being a partnership that is long standing, but certainly one that we've only increased the strategic nature of recently and there are a number of solutions, yet to be announced externally that we're working on in concert with Ericsson to I think give us both an additional sort of means of competing in the 5G opportunity. So just stay tuned for that.

Our next question is from Samik Chatterjee from JPMorgan.

Hi. Thanks for taking my question. I just wanted to start off with digging into the gross margin performance in the quarter a bit. You saw strong improvements in the gross margin on both products and services sequentially, even when like product revenues were sequentially lower. So just wanted to understand if there were any cost actions that you started off in 3Q itself outside of normal seasonality, what the other things that help gross margin here. And I think if I can ask more kind of 4Q and then beyond are there cost actions on the core business that you can take to improve gross margins?

Yes. So we're very pleased with our gross margin results in Q3 being above the range that we set in the beginning of the quarter. Clearly, we continue to undertake specific efforts to improve our gross margin, including innovation and design for value efforts as well as cost optimization within supply chain and customer service. Customer service, actually, the majority of the increase that they saw was not only a better volume from a sequential basis, but also good cost controls on the service delivery costs. So, that was really more of a cost controls perspective on the services gross margin uplift. On the product side, really the biggest driver was product mix as well as a little bit of geographic mix, but within product mix, we did see sequential growth in service provider and in routing all up and that's our highest margin product and within routing, even seen more mix of MX as compared to PTX was also a bit of a tailwind for our overall margin. So, those kind of product mix phenomenons that we saw in Q3, I do not expect to have similar mix in Q4. So when I guided Q4 at 60%, very much in line with our expectation and very much in line with our expectation that it would grow sequentially throughout the year. It is still down sequentially due to those mix impacts, not necessarily being as favorable in Q4 as we saw in Q3.

And if I can just follow up with one on the tariff impact. You mentioned that once you kind of take pricing, you might see some customer buying behavior changes. When you look at Europe customer segments, enterprises, service providers, customers, where do you see the most sensitivity to kind of pricing actions, if you take any pricing, where do you think you'll see kind of the most impact when it comes to buying behavior?

Yeah, I mean, difficult to predict at this point. At this point, I don't expect a material change in behavior. But it is a risk worth calling out. I think many customers are evaluating their own strategies within the tariffs and what is going to be monitoring and at this point, I don't expect it to be to impact our guide. However, it's just in a new risk I wanted to call out on the call.

Our next question is form Rod Hall from Goldman Sachs.

This is [indiscernible] on behalf of Rod. I have two questions. The first one I really wanted to just check in on the EMEA strength that you've been posting. Clearly, your EMEA business throughout 2018 has been better than at least the last couple of years. Wondering what's driving that strength, is it market share gains, is it service providers or enterprise traction, if you could quantify, that would be very helpful.

I'd be happy to. So very proud of the EMEA team for delivery and consistently throughout the year across the board really. So the strength is pretty broad-based across all technologies, routing, switching and security as well as in the service provider and we had pretty substantial momentum in the enterprise space as well. I think that the EMEA team under relatively new sales leadership has been executing well. I think that the solutions that we have developed, both for the telcos, in particular, what we have real strength in tier 1 telcos have resonated with many of our customers there that are looking for partners in making this cloud transition. And then in the enterprise space, I think there, our cloud delivered enterprise strategy where we're delivering value through a cloud delivered motion like SD-WAN being an example of that is resonating well with our customers over there as well. And from a momentum standpoint, I'm pretty optimistic that it can continue.

And just a quick one on switching as well. I think the performance in that business for the last three quarters or call it four quarters has been a little bit disappointing relative to consensus expectations. And if you look at the numbers that the street is modeling, the expectation for 2019 is a mid-single digit growth, while I recognize you won't be commenting on how much growth you expect, maybe would you care to elaborate on what would need to work for you for you to be able to get to that sort of growth or perform better than that.

Yeah. So let me say, I am disappointed in our performance in switching for Q3. I think that we can and we'll do better. And let me just double click on the switching business a bit for you to explain where the weakness was, but also where there is a strength and momentum that might not be evident by looking at the, the All Up number. First, there is an element of our switching business that is very much tied to the cloud architectural transitions in our large hyper scalers that has had an impact and continues to have an impact as we work through the timing of new deployments within the large hyper scale data centers or large hyper scale opportunities that are out there. Second, we had some specific weakness in Asia Pacific in switching mostly as a result of sort of difficult compares and timing of opportunities. But if I put those two factors aside, what I like about our switching business is first momentum in the enterprise, both in the data center and also in the campus and we've introduced new capabilities, new products like multi-rate capabilities in our switching portfolio that is gaining some real potential, real momentum and building pipeline for the enterprise in particular. Second, we're seeing solid telco growth with our switching portfolio, primarily driven by telco data center and telco cloud build outs that I've already talked about. Third 100-gig adoption in our switching portfolio is working quite well for us. So the pace of 100-gig growth or 100-gig capable product is actually growing far faster than the overall switching number is growing. And then last but not least, a big part of the very healthy all up software business that we posted for Q3 is a result of selling software capabilities, along with our switching portfolio. So I think these underlying elements of the business give me confidence that once we address the hyper scale architectural transition and of course we continue the momentum we're seeing in the rest of the switching business, we can get this business to growth next year.

Yeah. And we will update our long-term model at the upcoming Investor Day on November 9 and we're not going to get into specifics of 2019 right now, but I will say overall, we expect revenues to be up in 2018. As Rami mentioned, the architectural shift in the cloud should largely be behind us and we expect the cloud vertical to be a growth year in 2019. And we see continued strength in enterprise. We believe those factors have more than offset potential weakness in the service provider space. In addition to the top line growth, we are expecting profits and operating margins to expand in FY19 as well, but again, more details to come in our upcoming Investor Day.

And our next question is from Aaron Rakers from Wells Fargo.

Yeah. Thanks for taking the questions. I just want to go back on the MX and PTX router transition and maybe take a little bit differently in your service provider vertical. Can you just remind us again of what keeps that vertical from seeing a similar transition from MX to PTX longer term and how would you characterize the competitive landscape as you move towards the new Penta Silicon relative to what would be probably new platforms based on Jericho2, as we start to look into 2019 and I have a quick follow-up.

Certainly. So it's having understanding of how the ratio of MX to PTX looks like between the different verticals, really comes down to understanding the use cases. In the cloud space, in particular in the hyper-scale cloud, most of the use cases are about high-performance connectivity. The value is primarily delivered from the data center, right, software that's running in the datacenter. And so what the cloud providers value our cost optimization, programmability, telemetry capabilities, the ability to host their own applications on the systems for certain elements of control that they really need in their networks, whether that be in the data center or in the wide area and all of these factors point towards the PTX. And that's why the transition has happened so rapidly. In the telco space, as I've mentioned, the ratio of MX to PTX has largely been unchanged. I do expect that the PTX will pick up more dedicated, very optimized core use cases in time, but it will be a slow and sort of moderate transition. The main reason is that in the telco space, many of the services that are being offered by telecom operators have embedded in the networks themselves and have a degree of requirement sophistication, the only products like the MX can in fact offer. And you've mentioned the roadmap with the Penta Silicon. What we do is, even if our customers start to think about what it is that they need to deploy in order to satisfy their use cases, we're always innovating with new generations in the MX that are improving the capacity, the performance and improving the cost efficiency of that platform substantially that makes it so that, it's just not worth in many use cases to look at alternative platform. That Penta silicon gives us a 300% improvement in performance at half of the power consumption with all of the programmability capabilities that our customers love, built in encryption and a whole host of other capabilities that just our customers truly love. The last question, I think, since you've mentioned Jericho, the MX is really in a class of its own when it comes to the inherent programmability and flexibility of that platform. The Jericho platform, Jericho based platforms are more competitive with PTX type systems out there and that's the comparison that I would make, the MX really from a silicon and the software standpoint is not one that one could easily, in any way build using merchant silicon at least for the time being.

Our final question is from Jamie Fish from Piper Jaffray.

Hey, guys. Thanks for squeezing me in here. Actually, most of my questions have been answered and I won't ask the 10th question on the cloud vertical for you. I guess just on the software side, I assume you're going to give more color around what you guys expect that to get longer term. But what were the one-time items this quarter again on the 10% and why should we now expect that 10% level to sort of be maintained, as we move forward as your attach rates of software seem to be doing fairly well.

Yeah. Thanks for the question, James. So the components of software are broken out as follows. There is the newer software capabilities that we would describe as off-box. Our orchestration, our management software currently are -- obviously our enterprise Multicloud solutions, our off box software capabilities that would fit into that bucket and that is a small, but growing element of the overall software business. What is a more meaningful component is our Junos capabilities, our network operating system capabilities, where we have been executing on a very deliberate strategy over the last several years to disaggregate our operating system capabilities and give our customers choice of how much flexibility they want to buy and that's really working for us because it allows us to be very competitive with the appropriate pricing for less sophisticated use cases, but then to monetize the solution better as they go into more sophisticated use cases where the full breadth of routing and MPLS capabilities are required. I would say that that is a big part of the performance that we saw in the Q3 timeframe. There is a third leg of the software store, which is really around the solutions that are going to be offered to the enterprise like SD-WAN and so on. There is still a very small element today, but I expect, based on the momentum we're seeing in the market, I mean you saw just recently our Vodafone SD-WAN announcement that this element will grow in time. The reason why I wouldn't expect 10% on an ongoing basis is simply lumpiness, I mean, customers are going to buy the capabilities and the upgrades to existing deployed infrastructure based on the requirements and where I don't think it's reasonable to assume that every quarter going forward will be this level. However, I do think that this part of the business is working and over a longer term period, I do expect it to grow.

Yeah. And just to add to that, the on-box advanced Junos kind of features and functions are what we saw an uptick in, in Q3. While we have many different software models, the majority of our software today, particularly the on-box software is in perpetual model. So when those orders come in, which we saw a fair amount of those in Q3, they show up as a bit of a lumpy transition. As we move forward, we're working on different business models that would make that revenue more ratable, but at this point, some of that perpetual revenue was hitting Q3 and I don't expect that to be similar in the next couple of quarters.

So that's all the time we have today. Thank you all for your questions and we look forward to hopefully seeing you at our November 9 Analyst Day in New York.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.