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Fortinet Inc  (NASDAQ:FTNT)
Q3 2018 Earnings Conference Call
Nov. 01, 2018, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Fortinet Q3 2018 Earnings Announcement Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I'd now like to introduce you to your host for today's conference Peter Salkowski, Vice President of Investor Relations. You may begin.

Peter Salkowski -- Vice President of Investor Relations

Thank you, Gigi. Good afternoon, everyone. This is Peter Salkowski, Vice President of Investor Relations at Fortinet. I'm pleased to welcome everyone to our call to discuss Fortinet's financial results for the third quarter of 2018. Speakers on today's call are Ken Xie, Fortinet's Founder, Chairman and CEO; and Keith Jensen, our Chief Financial Officer. This is a live call that will be available for replay via webcast on our Investor Relations website.

Ken will begin our call today by providing a high level perspective on our business. Keith will then review our financial and operating results and conclude by providing our guidance for the fourth quarter, before opening up the call for questions. During the Q&A session, we ask that you please keep your questions brief and limit yourself to one question and one follow-up to allow for others to participate.

Before we begin, I'd like to remind everyone that we will be making forward-looking statements on today's call. And that these forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Please refer to our SEC filings, in particular, the risk factors in our most recent Form 10-K and Form's 10-Q for more information.

All forward-looking statements reflect our opinions only as of the date of this presentation and we undertake no obligation and specifically disclaim any obligation to update forward-looking statements. Also, all references to financial metrics that we make on the call today are non-GAAP unless otherwise stated. Our GAAP results and GAAP to non-GAAP reconciliations can be found in our earnings press release and in the presentation that accompanies today's remarks, both of which are posted on our Investor Relations website.

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

I will now turn the call over to Ken.

Ken Xie -- Chairman & Chief Executive Officer

Thanks, Peter and thank you to everyone for joining today's call to discuss our third quarter 2018 result. I'm pleased with our strong third quarter result as billing increased 22% to $528 million, total revenue was up 21% or $454 million. The product revenue up a solid 20%. Non-GAAP operating margin was 24%, we post non-GAAP earning per share of $0.49 and will again profit on GAAP basis, as earnings per share of $0.33.

We aim to continue to deliver above growth, balanced with profitability. We are experiencing strong global demand for our Security Fabric platform, due to enterprise digital transformation, increasing consolidation and the network security refresh cycle. Today enterprise need securities that will go well beyond SLA security proven product. This trend are expanding and opening up new opportunity for broad, integrated and automated Security Fabric protection.

The Security Fabric Platform offers three major competitive advantages. First, our fabric platform offers a broader set of our end-to-end solution providing protection from IoT for data center, also promise (ph) and cloud, organically fueled from grown-up from two decades of innovation. The security fabric provides the best automation and innovation in the industry.

An example is our Security Fabric cloud offering on Azure. We now provide the most extensive offering of integrated security solution available on Azure including FortiGate Next-Generation Firewall, FortiSandbox, FortiCASB, FortiWeb, FortiMail, FortiManager and FortiAnalyzer's.

A second differentiator is our superior price to performance capabilities. Fortinet is the only security company that fueled ASIC secured a process of SPU is integrated security and a network functionality, which provide a 10x speed and performance of other software approach. As a result, Fortinet's product provide significant and better security performance for both cloud and edge computing. The search competitive differentiator is our Security Fabric Platform is the extensive third-party recognition and validation, we have received from NSS Lab and Gartner.

Fortinet has received a recommended rating in 9 out of 9 in NSS Lab categories. More than enough of the number of recommendations received by our nearest competitors. Fortinet was among only three vendors out of 10 that received our recommendation for their SD-WAN solution and that the only vendor, who had received recommended rating in both SD-WAN and the Next-Generation Firewall group test.

Fortinet, Fabric Platform solution have now appeared in seven Gartner Magic Quadrant over the past 12 months. Our SD-WAN solution was recognized as one of the top 5 solution in Gartners. WAN Edge Magic Quadrants, also Fortinet was named in all the Leader Quadrant for next-generation enterprise firewall and the unified threat management. SD-WAN pays a pivotal role in realizing the true benefit of digital transformation and is forecast to reach $4.5 billion by 2022, up from $1 billion in 2018. Gartner said by 2023, 50% of our new firewall purchases in the distributor network will utilize SD-WAN features. Fortinet offers the only solution that provide also SD-WAN and the Next-Generation Firewall functionality in a single integrated offering for enterprise and SMB.

We believe this technology advantage put Fortinet in a solid position to capitalize on strong SD-WAN market growth. Last week, Fortinet announced the acquisition of ZoneFox, a cloud-based inside threat detection and response company. Acquisition further enhance the Security Fabric Platform and strengthening our existing endpoint and same security through machine learning, providing a better a faster response to inside threat. Innovation is core to Fortinet's mission. In the third quarter, we surpassed the milestone of 500 each of the patents, three times the patents issued for our nearest competitors. We are pleased that we added to the S&P 500 Index an acknowledgment of our double-digit year-over-year growth every quarter since going public in November 2009 and our consistent GAAP profitability. We're excited about the significant opportunity ahead and we will continue to invest, while achieving our goal of 25% operating margin at 2022. I want to thank the Fortinet team and our partner for their ongoing hard work and our customers for their support.

Now I would turn the over to Keith for a closer look and our third quarter performance and our fourth quarter guidance.

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Thank you, Ken. Before I start, I'd like to note except for revenue, all financial figures are non-GAAP and growth rates are based on comparisons to the prior year period, unless stated otherwise. Any slide references that I make during my prepared remarks, refer to the presentation that is posted on our Investor Relations website.

I'm very pleased with our third quarter results. As the Fortinet fabric, continue to resonate with existing and new customers. In the third quarter, we posted revenue growth that outpaced the industry, and operating margin it was better than expected and strong free cash flow. We believe we are well positioned to outperform the security market in the fourth quarter. We are delivering an integrated and high performing fabric product portfolio, which is driving an industry leadership position. This claim is supported by the independent recommendations we've received from NSS Labs and Gartner. Specifically, I would point to our 9-to-9 record of NSS Labs product recommendations, as well as Gartner evaluating Fortinet as a leader in both our UTM and enterprise firewalls Magic Quadrants.

We remain committed to balancing above market revenue growth with increasing profitability. As we work to achieve our non-GAAP operating margin goal of 25% for the full year 2022.

Now for our third quarter results, starting with revenue. As shown on Slide 3, revenue grew 21% to $454 million. Product revenue growth accelerated to 20%, resulting in revenue of $165 million. Product revenue included a net benefit of $2 million related to the required accounting change from revenue. Excluding this benefit, product revenue growth accelerated to 18%, service revenue grew 22% to $289 million, FortiCare, our traditional support offering grew 26% to $121 million and FortiGuard, our security subscription offering grew 20% to $157 million. Deferred revenue increased 27% to $1.5 billion, average contract length increased 1-month to 26 months and was flat sequentially.

Turning now to billings. Billings grew 22% to $528 million. Each region, experienced strong billings growth to the Americas, APAC and EMEA, up 25%, 22% and 19%, respectively. The US provided strong enterprise growth in the quarter, accounting for 7 of our top 10 and the majority of our top 25 customer billings. Billings to our Global 2000 customers, excluding service providers and MSSPs on a trailing 12-month basis grew 31%. One of our top 25 billings in the quarter was a seven-figure transaction with the same large US retailer we highlighted in the first quarter for their -- there then seven-figure all cloud transaction.

New transaction was focused on our ASIC-based FortiGates, including several of our high-end 6000 Series of products. These high-end FortiGate products will be deployed this year to secure connectivity with their earlier cloud deployment. We also completed a quadruple competitor displacement with a large US based financial services firm, initially looking to improve their internal segmentation capabilities. At a very successful proof-of-concept, the firm decided to displace additional vendors, consolidating their functionality with Fortinet then lowering the total cost of ownership.

Also in the quarter, the large US multinational financial services firm that was highlighted in our last call appeared again as a top 10 customer with another seven-figure billing this quarter.

Illustrating the strength of our mid-enterprise and enterprise business, the number of deals over $250,000 grew 27%, while the billings associated with these deals increased 34%. Number of deals over $1 million were fairly consistent year-over-year, moving from 32 to 30. The total dollar billings associated with these $1 million plus deals increased 32%. Service providers and MSSPs continued as our largest vertical, accounted for 19% of billings, up 2 points year-over-year. Network security billings increased 22% accounting for slightly more than 0.75% of total billings. Billings for non-FortiGate grew faster than the FortiGate business. The Security Fabric, which is the largest component of our non-FortiGate offerings and it fitted from customers recognition of its value, performance and integrated security coverage. Cloud billings for our top 5 public cloud providers continued to experience growth in excess of 100%.

Moving back to the income statement. Our third quarter gross margin increased 50 basis points to 76.5%. Product gross margin was down 120 basis points to 57.4%. On a quarter-over-quarter basis, product gross margins were up 90 basis points, as we continue to transition through a certain level of volatility related to new product introductions. Service margins expanded 120 basis points to 87.3% and 50 basis points, sequentially. Including the commission benefit associated with the required change in accounting, total operating expenses grew 11%, excluding the benefit from the required commission accounting change, total operating expenses would have been up 15%.

Including a 240 basis point benefit from the commission and revenue accounting changes, our operating margin of 23.9% was up 520 basis points year-over-year.

Excluding any benefit from these accounting changes, our third quarter operating margin increased by 280 basis points year-over-year. The operating margin improvement was mostly driven by leverage in our financial model as revenue growth outpaced total operating expenses.

Slide 14 shows a line-by-line comparison between our non-GAAP results and the non-GAAP results excluding the adoption of the new accounting rules. In the fourth quarter, we expect total operating margin benefit from the required accounting changes to be about 250 basis points. The full year, the operating margin benefit is expected to be about 300 basis points. Total headcount at the -- in the third quarter was 5,639, up 15%. Net income to the third quarter was $87 million or $0.49 per share based on $175.7 million diluted shares and was up 75% year-over-year. Non-GAAP effective tax rate was 24%.

Moving to cash flow and capital, summarized on Slide 7. Cash from operations was $177 million, up 9% year-over-year. Free cash flow was $159 million, up 13% year-over-year. On a year-to-date basis, free cash flow increased 32% to $417 million. Capital expenditures in the third quarter were $18 million. Given the strong growth we've experienced, we'll outgrow our existing office space in Sunnyvale. As a result, we have started construction on a building adjacent to our existing office.

In the fourth quarter, we expect capital expenditures in the range of $5 million to $10 million related to this building. We expect total fourth quarter capital expenditures to be between $20 million and $30 million. Total capital expenditures for 2018 are expected to be between $60 million and $70 million. Capital expenditures related to the adjacent building are expected to be in the range of $60 million to $80 million in 2019. We plan to provide quarterly spending updates throughout 2019. And plan to move into the building in 2020.

As I turn to guidance provided on Slide 9, I like to remind everyone that the forward-looking disclaimer Peter presented at the start of the call, applies to the guidance I'm about to provide. For the fourth quarter, including the benefit of ASC 606 and then immaterial impact from tariffs and cost of goods sold, we expect billings in the range of $620 million to $635 million; revenue in the range of $490 million to $500 million; non-GAAP gross margin of 75% to 76%; non-GAAP operating margin of 24% to 25.5%; non-GAAP earnings per share of $0.50 to $0.52. This assumes a share count of between 178 million and 179 million.

2018 including the benefit of ASC 606 and then immaterial impact from tariffs on cost of goods sold, we expect billings in the range of $2.125 billion to $2.140 billion, revenue in the range of $1.785 billion to $1.795 billion, non-GAAP gross margin of 75% to 76%, non-GAAP operating margin of 21.5% to 22% and non-GAAP earnings per share of $1.72 to $1.76, which assumes a share count of between 174 million and 176 million. Before I turn the call back over to Peter, like to thank our partners, our customers and the Fortinet team for all their support and hard work. I'd also like to welcome the employees of ZoneFox to the Fortinet family.

I'll now hand the call back to Peter.

Peter Salkowski -- Vice President of Investor Relations

Thank you, Keith. Operator, we're ready to open up the call for Q&A, please.

Questions and Answers:

Operator

(Operator Instructions) And our first question is from Jonathan Ho from William Blair. Your line is now open.

Jonathan Ho -- William Blair -- Analyst

Hi, good afternoon and congratulations on the strong quarter. I just wanted to start out with maybe the Security Fabric, it sounds like this is another strong quarter in terms of demand. Can you maybe give us a little bit more detail in terms of what elements of the fabric maybe stood out? And also, do you have a separate code for the sales force to retire related to the Security Fabric?

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Hi, John. This is Keith. Second question first. No, we do not have a separate quarter for the fabric -- for the sales team. If you look to the product family, I would highlight the access points in the switches performed very well in the quarter and that continues a pattern that we started see shaping up in the beginning of the quarter as well. I think, also, I would add to that list, 40 manager, 40 analyzer, 40 SEM, overall, the product suite of the fabric performed very well during the quarter.

Jonathan Ho -- William Blair -- Analyst

Excellent. And then just looking at the operating margin trends, I mean, you guys have guided to a pretty strong operating margin in the fourth quarter after delivering a strong third quarter. How should we be thinking about that on a go-forward basis? I know, you guys make some investments early in the year as well that start to show leverage, but I just want to make sure that we're thinking about it the right way?

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Yes, we're not in a position as we go through the budgeting cycle that we're in right now for the coming year to really talk about guidance for 2019. Obviously, we're very pleased with the performance of the Company in Q3 on the top line and on the operating margin line. I think the productivity from the sales organization, you're seeing that come into play in the third quarter. We're very pleased with that. I probably leave it to Ken to talk a little bit about market forces and what we're seeing beyond just the fabric growth and other comments as well.

Ken Xie -- Chairman & Chief Executive Officer

Yes, actually, we saw strong building growth like a 22%, our headcount hiring probably behind that. So the healthy way for long-term growth need to be sync together for the top line growth and the high term growth. So that's where we make (inaudible). On the other side, we do see the refresh cycle still going on, maybe what be last out of 1 to 2 years. The other opportunity we see is SD-WAN is a huge opportunity like I mentioned in the script, in the next few years will be reached from this year $1 billion to $5 billion and where only vendor can provide also SD-WAN and also security single path, single solution. it's a huge advantage for all of our enterprise SMB service provider. We see a lot of strong demand, we believe, this trend will be carry for another few years growth -- very strong growth. So that's where we want to keep in balance among the growth and the profitability. So we were a company can post the top line and bottom line. We also have the commitment 25% operating margin by 2022, but we also want to keeping -- imagine the growth going forward.

Jonathan Ho -- William Blair -- Analyst

Great, thank you.

Operator

Thank you. Our next question is from Sterling Auty from JP Morgan. Your line is now open.

Sterling Auty -- JPMorgan -- Analyst

Yes. Thanks, hi guys. I get a number of questions from investors trying to understand, especially in the high-end enterprise. How much of the demand and success you're seeing, you are still data center focused versus now with all the talk of fabric and micro-segmentation. So just maybe some additional color around what's driving the success in particular in the high-end enterprise part of your business?

Ken Xie -- Chairman & Chief Executive Officer

We do see both growing well, whether in the data center cloud and also in the internal -- internal segmentation and edge computing because once in the Android study realize really when they moved the data to the cloud, they also need to securely access to it, and it actually at some additional risk because now in the cloud as if you cannot secure access now, then the data probably more risk, most dangerous there. So that's how to secure access to data especially leveraged like SSL encryption and other is very, very important. But most other (inaudible) secured solution there have a big performance issue with SSL encryption. But we have the ASIC solution, which -- when you do that SSL encryption for the traffic you almost -- no traffic drop compared with other solution test is about 80% top on the -- of the throughput. So that's why we see is -- as a sort of enterprise, when this hybrid and I'll move some data to the cloud compare some more internally. So they need a balance amount of what's the data go to the cloud, what's data and what's the computing still within the edge, within enterprise . So we see enterprise definitely keeping increases security spending even from IT spending probably pretty much flat. So as still, we are healthy and we continue believe the security will grow like a 10% or even above in the next 10 plus years at a total market that's kind of reached like a $1 trillion in the next 10 to 20 years. Its where how you see long-term growth market.

Sterling Auty -- JPMorgan -- Analyst

Got it. Thank you.

Operator

Thank you. Our next question is from Shaul Eyal from Oppenheimer & Company. Your line is now open.

Shaul Eyal -- Oppenheimer & Company -- Analyst

Thank you. Good afternoon, guys, congrats on the beat and raise. Ken probably one for you and one for Keith. Going back to the refresh product cycle, you've been around during your entire career within the security arena. As you think about the current cycle, would you characterize that as if were in the initial innings, midway, how would you think about it versus prior cycles, timing and maybe even demand and product wise? Thank you.

Ken Xie -- Chairman & Chief Executive Officer

A few of this cycle compared to the rush by happening end of a 2012, 2013. This probably last a little bit longer. Maybe a few quarter longer, maybe last for like a 2-year, 2.5, 3 years. We are probably close to meet of it, but the difference is this time they come -- they consider multiple solution together whether fabric of platform. So they also need to find a way to integrate to automate a solution compared to the last cycle that's refreshed from the regular firewall to the next-gen firewall UTM. And that's where this time they need to consider how this different piece can work in together whether from the network side, endpoint, the could, the networking side even some storage and IoT. So that's where they kind have a more bigger picture kind of infrastructure can approach compared to less than our side. So that -- but also we see some kind of a new infrastructure, like SD-WAN, or the 5G, similar like in the past, we see also our strong part of fabric gross really to Wi-Fi also need to be considered together with security. So that we see is kind of the total infrastructure fabric platform approach is happening right now and consider the security integrate are designed with the infrastructure instead like a add on top of some infrastructure.

Shaul Eyal -- Oppenheimer & Company -- Analyst

Got it. And understood. Thank you so much for this color. Maybe one for Keith. Really strong showing on the DSO front probably lowest in some quarters, doesn't matter whether it's 605 or even 606. Can you talk to us about that and maybe also about linearity trends you have been experiencing through the quarter? Thank you.

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Yes, thanks for your nice comments. Yes, I think DSO came in -- I don't think there was anything really unnatural on the numbers. And hose kind of lead up to your second part of your point, I think when the early in the quarter was indeed good and it kind of held its pace commented on about the first month of the quarter and the last earnings call, being good. And I think it kind of continued on through the quarter. And I think you're seeing that in the DSO number.

Shaul Eyal -- Oppenheimer & Company -- Analyst

Understood. Thank you so much. Good luck.

Operator

Thank you. Our next question is from Andrew Nowinski from Piper Jaffray. Your line is now open. Andrew, your line is now open.

Andrew Nowinski -- Piper Jaffray -- Analyst

Can you hear me?

Operator

Yes, we can hear you now.

Andrew Nowinski -- Piper Jaffray -- Analyst

All right. Thank you. Well, congrats on a nice quarter. I just want to ask about the large customer win that you had the quadruple replacements, since that was clearly more than a firewall replacement. Can you give us any color as to what products that customer consolidated onto the Fortinet platform?

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Yeah, you're going to -- when you start to see multiple products like that is going to go beyond the firewall right into the fabric, right and more often, now you'll see, as I indicated previously from a hardware viewpoint the access points and the switches are doing very well, and then you roll into that typically a suite of 40 manager, 40 analyzer, SIEM cloud et cetera.

Andrew Nowinski -- Piper Jaffray -- Analyst

Okay, got it. And then just maybe a comment on the large deals, they look like they were down. I'm talking about $1 million deals were down, sequentially, did any deals pushed out into Q4 that might have caused that number to be down year-over-year?

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

I don't -- I think when you look at that population, again, I think it was up by 2, I think year-over-year from 32 to 30. You're going to get a little bit of volatility in that segment of the market. So I'm not surprised by it. I was very pleased to see the total dollar value that was build in those large deals even though the number was smaller. The total billings were up about 34% I believe, I said.

Andrew Nowinski -- Piper Jaffray -- Analyst

Okay, got it. Thanks, congrats.

Thank you.

Operator

Thank you. Our next question is from Keith Bachman from Bank of Montreal. Your line is now open.

Keith Bachman -- Bank of Montreal -- Analyst

Good evening. Thank you. I wanted to ask two questions if I could. First, the services revenue has been humming along at 25%, 26% year-over-year growth for five quarters. Does this quarter, desell a little bit again larger number, but desell to 22%, while the product revenue, its second straight quarter of really good growth. And so I'm just wondering was there anything on the services side -- any reason why desell outside of larger numbers? And what does that portend that the product revenue growth has been so strong for a couple of quarters now? Does that -- it's just an inflecting point in terms of acceleration back to the services side? Then I have a follow-up if I could.

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Okay. Hi, Keith, it's Keith. How are you?

Keith Bachman -- Bank of Montreal -- Analyst

Great, thank you.

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Yes. Look, I think, obviously, we're very pleased with the results of the quarter, both on the top line and the bottom line. And as you know, we manage -- we guide to total revenue into the margins. So within that mix of services and products, we are very pleased with where we end up, including the gross margin line. I think a little more specific to your question, one thing we looked at was our renewal rates were very good in the quarter, up over what we normally see, the tax rates were very good, the mix of 24/7 versus 8/5 support was very good, it ticked up again. As I said, renewal rates and attach rate -- so the -- I think is a larger base as part of it, as you point out. I think the other key element of this is something that we talk about a little bit in the Analyst Day. The fabric platform came online, we expected to bring with it the higher mix of hardware and that higher mix of hardware, what you're seeing in the top line on the product revenue growth, and then also smaller mix and services and I would really point to access points and switches for that. But I think you're really starting to see the impact of the platform strategy from the fabric and how its appearing in the success it's driving in the income statement.

Ken Xie -- Chairman & Chief Executive Officer

Also we introduced a new service called the FortiCare 360 and that's beyond the traditional FortiCare 8/5 support and then 24/7 supporting. This will be help in the fabric service going forward, is helping to manage, to configure, to deploy and also to house check off some of the fabric solution there. It's due in the early ramp up stage and -- but we do believe, including the future, fabric and also the new trend SD-WAN, so this service needed and we see also were quickly ramp up even that's in the early stage. We believe this will help in the future service growth.

Keith Bachman -- Bank of Montreal -- Analyst

Okay. And then my clarification Keith is just, you guys have provided operating margins for the year, and let's just say forget giggles, it ends up being 22% operating margin, pursuant to ASC 606. When you talk about growing to that target of 25%, I assume the base that we should think about in 2019 is 22%. In other words, the base is an ex the benefit of the accounting translation as we think about 2019?

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Yes. I think the way we've always described it is that that's a 605 number and we're tracking the 605. And as part of that, the reason we're looking at a 605 number in terms of that commitment is, as you can see it's moving around on us, right. It's coming down from the first quarter to the fourth quarter and that can be impacted by things like product revenue mix, comp plans, service term et cetera. So I think just to keep us all very honest outside of the table, it's a 605 goal.

Keith Bachman -- Bank of Montreal -- Analyst

Okay. But as we think -- so if we think about 2019, again, just using 22% as the reference point, should we expect operating margins to be flat, down or up relative to 22%?

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

For 2019?

Keith Bachman -- Bank of Montreal -- Analyst

Yes.

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Yes, I'm going to pause on providing guidance for 2019, other than offering up our long-term model that we've talked about before and what we we're targeting over time.

Keith Bachman -- Bank of Montreal -- Analyst

Okay.

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

This is -- let me go through my budgeting process and cycle before I do that.

Keith Bachman -- Bank of Montreal -- Analyst

Okay, thank you.

Operator

Thank you. Our next question is from Gabriela Borges from Goldman Sachs. Your line is now open.

Gabriela Borges -- Goldman Sachs -- Analyst

Good afternoon. Thank you. I wanted to follow-up on some of the momentum you're seeing in the Global 2000. I have it kind of for Keith, could you comment on to what extent the volume of opportunities, the number of engagements that you're invited to bid upon, how is that changing relative to history? And then if you could also comment on win rates for Global 2000 business, once you're invited, how often do you win, is that number changing at all? Thank you.

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Hi, Gabriela, its Keith. How are you? I would say the pipeline in total, we very pleased with the direction of the pipeline. And the segmentation of the pipeline, I think the fact that I'm pleased both our very important S&P part of our business and also the Global 2000 part of the business. I think the -- we're well positioned with an opportunity to continue to lead the S&P and expand into the enterprise. And I think that trailing 12-month number of 31% growth is a very positive indicator. In terms of wins and losses, that's we're not -- other than the carrier on SSP we're not the incumbent, it's always a little more challenging to displace the incumbent, but I think when we have those opportunities, we're doing well and we're very pleased with it.

Ken Xie -- Chairman & Chief Executive Officer

Yes. Also we are starting to invest in the market chain and supporting -- to supporting the -- to support the sales into the Global 2000. We see pretty good progress there. And at the same time, even within ourselves, we're starting kind of a separate some of the effort organization, but we're focusing a channel -- are focusing the Global 2000. So that's where -- once we have the focus, we can see the growth pretty healthy.

Gabriela Borges -- Goldman Sachs -- Analyst

That's helpful. Thank you. And follow-up on the gross margin. Can appreciate that gross margins are expanding in aggregate year-over-year, but I wanted to ask specifically on product gross margin. Could you help us understand, that's for Keith, when that number might start to trend upwards or when you might start to see stabilization within that product gross margin line? Thank you.

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Yes, I think that's a fair question. I'd probably just can offer you some context. It can be impacted by the mix obviously between products and services in any of the quarter. Specifically when you look to Q3, the Q4, the sequentiality are mixed typically, picks up a little bit the product, which puts a little bit of pressure on the gross margin line. I do expect that we're going to continue to see growth and improvement in total gross margin and largely driven by the services component of that. (Technical Difficulty) And I think we're kind of the fast forward to the punch line, we're on track to that 25% goal and that gross margin line as a component of that.

Ken Xie -- Chairman & Chief Executive Officer

Yes. Also like early this year during the Analyst Day a preview there and wholesale, we do see the long-term gross margin targets are 80% and the same time we refresh some of the middle-branded product during the refresh time the gross margin just drop a little bit and then will come back up once the ramp up starting to finish. So we can see the long-term trend is still the same and was still keeping the 80% target for gross margin.

Gabriela Borges -- Goldman Sachs -- Analyst

I appreciate the color. Thank you.

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Thank you.

Operator

Thank you. Our next question is from Fatima Boolani from UBS. Your line is now open.

Fatima Boolani -- UBS -- Analyst

Good afternoon and thank you for taking the questions. Keith, maybe to start with you. Just on the service provider business, just according to my math, that was a nice acceleration off of the second quarter. So can you give us a sense of what sort of budgeting behavior is actually playing out in the service provider vertical that underpin the strength? And as we look into next year, what sort of activity are you anticipating? And another follow-up if I may.

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Yes, I think the and Ken help me in a way in here a little bit, but I think the MSSPs portion of that service provider is really what you're seeing and that's historically been the largest part of our business and we're seeing that do exceedingly well. I think the SD-WAN discussion now is really coming into play as part of that business as well and I think you're seeing that starting to drive and then I had some conversations with customers. That SD-WAN opportunity is really starting to drive some pipeline growth. I think 5G will be a part of it as well.

Ken Xie -- Chairman & Chief Executive Officer

Yes, that's where we do see the SD-WAN technologies starting kind of be used by some new -- relatively small service provider with a market share from the traditional MPLS offered by some of the bigger carrier service provider. So -- and the same time, the 5G, some other technology starting taking off now. So our philosophy is working with service -- all kind of service provider, both large and small and offer the best product in pool and these unsecurity into the service they're offering. So we see this strategy working quite well. That's where we had only one offered SD-WAN to kind of a security, Wi-Fi together with security. And also going forward some other news things always security together. So that's the strategy, the service provider like a lot. That's what compared with some other, like a network vendor or the the security vendor, they have to catch up to buying company to follow the trend comparably kind of a long-term invest in all these year, a few years ago and keeping investing for the long-term offer integrate automated solution, which is much better for the service provider, for the customer.

Fatima Boolani -- UBS -- Analyst

That's helpful. And Keith, just a quick one. Last couple of quarters, you gave us some color on shipment volumes. I just wanted to see if there is an update there and to the extent it's sort of held into the 20%-ish zip code. How should we think about that from a sustainable basis. Looking at the next couple of years, as we think about hybrid architectures and cloud migration? And that's it from me. Thank you.

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Sorry about that. I already discuss all of the thing, there are words in my script. FortiGate unit shipments up 16% year-over-year, all shipments up 20% year-over-year. I mean 21%,, but I'll go with 20%.

Fatima Boolani -- UBS -- Analyst

Thank you.

Operator

Thank you. Our next question is from Daniel Ives from Wedbush Securities. Your line is now open.

Drucker Becky -- Wedbush Securities -- Analyst

Hi. This is Drucker Becky (ph) for Dan Ives. And our question is based on your conversations with customers. Are you seeing an inflection point with larger scale security deployments in the field? Thanks.

Ken Xie -- Chairman & Chief Executive Officer

I see multiple solution in there, we prepared to deploy. Yes, we do see some time a deal get larger and -- because when you have a multiple solution integrate automate together, unless you can -- I'm not sure that's a trend or not, it's still early to say like a bigger deal or the bigger customer make at the over $1 million deal, the sales get bigger, the number are not quite were flat. But I do see the deployment starting need to be more integrate, more kind of a multiple solution working together now.

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Yes, I would just kind of -- can spot on. And I would just kind of remind people that often times we see stays deployments with large enterprises. And so you will see some of these deals appearing -- for a single customer then rebuying in Q2, Q3 and then again in Q1 or something like that. So it's difficult to look at individual customer because of the -- it's more than one quarter and offer a comment on that. But yes, the enterprise does drive larger deal sizes, whether that's just because of the number of firewalls or because of the fabric products that are being attached to it.

Ken Xie -- Chairman & Chief Executive Officer

Yes, I think also we believe we have assured advantage because most our fiber part are though internally, organically design from the day one the design to work together, integrate together, and also including some networking function like SD-WAN compared to some other company they have to purchase some of this product solution, which always more difficult for the integration and I think time to making working together. So we have huge advantage, so we do see a benefit getting bigger and bigger now.

Drucker Becky -- Wedbush Securities -- Analyst

Great. Thanks for the color guys.

Operator

Thank you. Our next question is from Rob Owens from KeyBanc Capital Markets. Your line is now open.

Rob Owens -- KeyBanc Capital Markets, Inc. -- Analyst

Great. Thanks for taking my question. As you guys are clearly in share gain mode, especially given the product success that you're seeing. What's the competitive response been, what's the pricing environment like?

Ken Xie -- Chairman & Chief Executive Officer

We don't have any price pressure right now. So that's why we're keeping view the gross margin continue to be improving because one of the key differentiator is we are only one design ASIC chip. Now we -- these are like close to 4 million for deploy and also the economy skills starting working whether the poll side effect the more we deploy, and it can also lower the average of cost for the chip and also design average per chip. And the same time, can see more benefit we can invest more in there, but ASIC chip take a long time, 5 to 10 year to see the benefit. So far, none of our competitor being able to invest early enough to get in the space to see the benefit we have. So once we have a bigger and bigger number unit deployment, market share, we also see a salary, the benefit will help us to keep a differentiated advantage more. I think, yes, that's very much, right?

Rob Owens -- KeyBanc Capital Markets, Inc. -- Analyst

I guess, second, with regard to be in the September quarter, and I apologize if I missed this in the prepared comments. But any discussion around the Fed, it seemed like you had decent success in that vertical, as well?

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Yes, I think the -- all of our U.S. government vertical, which is a vertical that we previously disclosed they have a good quarter. We are pleased with it. And I do think that there was a little bit of -- I think the US Fed part of that business, which again is a subset of our total vertical did well in the quarter.

Rob Owens -- KeyBanc Capital Markets, Inc. -- Analyst

Thanks.

Operator

Thank you. Our next question is from Melissa Franchi from Morgan Stanley. Your line is now open.

Melissa Franchi -- Morgan Stanley & Co. LLC -- Analyst

Okay, great. Thanks for taking my question. A question for Ken or Keith. Just wondering if you can maybe comment on what you're seeing in terms of sales cycle. So on one hand, it seems like it's a very healthy security demand environment and you're seeing good refreshes. But on other hand, you're now selling a broader suite with the security fabric that might require a broader rethink of the security architecture. So just wondering if that's creating maybe a little bit of elongation in the sales cycle?

Ken Xie -- Chairman & Chief Executive Officer

I agree, it's worth a point. We do see a (inaudible) take a little bit long time when they consider multiple solution, multiple product need to be working together. But also that's can make the deal also larger, and also we have to train both our sales force and partner, how to sell multiple product and make it all working together, as a fiber solution is a market point trend for this time the refresh cycle.

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Yes, I think we feel very good about the sales cycles. I mean there is -- again, because we have success in both the S&P, the channel, the carrier, as well as the enterprise. Looking at the numbers for the quarter, I don't think that the longer sales cycle was the issue. I certainly do see us building things in our pipeline that -- I guess, I would call, longer term and perhaps larger dollars. But those are much further out.

Melissa Franchi -- Morgan Stanley & Co. LLC -- Analyst

Okay, great. And then just one quick follow-up for you, Keith. You mentioned the contract duration this quarter was up, just a little bit year-over-year, I think 1-month. How should we think about how that trend for Q4? And then any visibility into 2019 from a contract duration perspective?

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Yes, I think not something I would normally guide to, let's say, and I think previously I have talked throughout the year that we would expect that contract term would tick up during the year, and I think that's probably going to continue on to the fourth quarter.

Melissa Franchi -- Morgan Stanley & Co. LLC -- Analyst

Got it. Thank you very much.

Operator

Thank you. Our next question is from Gregg Moskowitz from Cowen. Your line is now open.

Gregg Moskowitz -- Cowen & Co. LLC -- Analyst

Okay, thank you very much. First question for you Keith, this quarter FortiGate billing grew very well, and they continue to hover around 75% of total. And I know that you're not yet providing guidance for next year, but just from a high level. How should we be thinking about the mix for FortiGate versus non-FortiGate over the next 12 months or so?

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Well, I think if I look back over the last -- for this year, at least, there is pretty much kind of hovered in that similar mix, if you will. We are very pleased with the FortiGate fabric platform, and we will certainly continue with that as a key point of our strategy throughout 2019.

Ken Xie -- Chairman & Chief Executive Officer

Here the non-FortiGate grow little bit faster than the FortiGate, but interesting with -- now we offer SD-WAN within the FortiGate. We're starting to add into some -- the infrastructure solution deployment, we should have the security design in. So that's actually will help in the FortiGate side. So we are not quite sure going on, but definitely we see the non-FortiGate so far into this year, they grow faster than the FortiGate. But SD-WAN may change in is a little bit, but overall, we do see, this will also bring additional service and also make the total solution better and because as the marketable solution or with the customer is also making most (inaudible) the customer.

Gregg Moskowitz -- Cowen & Co. LLC -- Analyst

Okay, that's helpful. And then Ken, how should we be thinking about the timing of the next ASIC product cycle for Fortinet?

Ken Xie -- Chairman & Chief Executive Officer

I'd say it's pretty close. I think will be -- within the next few months or few quarters is about to close now. About every quarter we do refresh some other products like some of the middle range, some of the -- and now, so we do have a last year, we have like called CP9 come out last year, which we're improving SSL encryption quite a lot, is more like a 15x improvement. So that's a huge advantage when you try to deploy the cloud access. So looking good on a cloud and edge.

Gregg Moskowitz -- Cowen & Co. LLC -- Analyst

Okay, terrific. Thanks very much.

Operator

Thank you. Our next question is from Michael Turits from Raymond James. Your line is now open.

Michael Turits -- Raymond James -- Analyst

Hi, guys. Michael Turits from Raymond James. Thanks very much. Ken for you -- back to the cycle question, there is some concern about a fall-off in IT spending overall into 2019. Are you starting to see anything that would suggest any hesitancy in terms of buying as people exercise some caution regarding the macro economy?

Ken Xie -- Chairman & Chief Executive Officer

Yes, they do have a little bit concern in the last couple of months, that is -- but we don't see the security, -- security within IT spending still keeping increase. So even the IT spending flat. We do see the security we're keeping growing like a 10%, 15% and that's why also I believe the next 10 plus years we'll reach to $1 trillion market as a bigger security is kind of more and more important for all of the business we are doing here, all connect together and also passed an additional like IoT security and the past the cloud some other part. If you see the overall security spending is not decreasing, but keeping similar pace in the last like 27 years.

Michael Turits -- Raymond James -- Analyst

Okay, thanks. And then, Keith, can you talk a little bit about the specific thing that you've been doing in the channel and in the field in general, in order to help move Fortinet up market. I know that you had talked about increases and incentives to sales a little while ago. Can you be specific about where you are with that as well as what you're doing in the indirect channel?

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Well, a lot of credit goes to the sales team. I think for their execution together with support from the marketing team and the R&D team. So -- but I am not sure that's -- if you're asking about comp plans specifically, I think we've talked previously that we did create a separate commission element for products in the second quarter. I think more importantly and specifically with comp plans, one thing we did in the US at the beginning of this quarter is we actually took the next step and separated the SMB business from the enterprise business in terms of how those compensation plans work and who is responsible for it. And I would say, I was ecstatic with the results on both ends of the spectrum, the S&P channel in the US did extremely well and the enterprise and the US did extremely as well -- too. I think there is just -- those teams performed extremely well. We got a little lift in productivity probably from that. And as we've talked before that I expect, I don't see us separating the company. But I do see us continuing with our focus and how we go-to-market in these different segments and continuing to invest in both.

Michael Turits -- Raymond James -- Analyst

Great, thank you very much guys.

Operator

Thank you. Our next question is from Brad Zelnick from Credit Suisse. Your line is now open.

Brad Zelnick -- Credit Suisse -- Analyst

Excellent, thanks so much for taking my question. And I'll just say that I continue to hear great things in the field about the security fabric message and the product offering as well as your SD-WAN product, sounds like it's really gaining great traction. But my -- and it's easy to see why you're gaining share in the market as a result of that. But my question is actually around security fabric on Azure, which can -- you mentioned in your prepared remarks and I know it's only about a month or so ago that you announced the expansion of that offering to include more of the fabric components. I'm curious, again, I know it's early, but can you maybe comment a bit about how you see customers embracing your offering versus the native capabilities within the Azure platform itself, such as Azure firewall service for example.

Ken Xie -- Chairman & Chief Executive Officer

I think we have the approach more like a hybrid solution and that's where like customer has the freedom whether deployed our price on their prime result, some data application go to the cloud. For the Azure, the same -- we have also the broadest security cloud offering, whether Azure on the AWS on some other like Google, Oracle, IBM, some other cloud. So that's where we want to offer the broadest, the best solution, which customer can select, how to best fit their need and also offer a flexibility to transfer between -- changing between wider on-premise and also on the cloud. So that's different compared to some of the native cloud provider offer some of the security service, which they more focus in certain application only, is not based on the networking side or the infrastructure side. So that's where we are not competing with them. It's more like a different layer of security. So we are more on the infrastructure layer, on the network side and on the computer, we are most focused on certain application.

Brad Zelnick -- Credit Suisse -- Analyst

I appreciate that color, Ken. And for Keith, in your prepared remarks you talked about the impact of tariffs on certain aspects of the results and I think intra-quarter, you might have commented on this publicly, but can you just spell out for us exactly what the situation and exposure is to China trade tariffs? Thanks.

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Yes, the headline will be less -- in Q4 will be less than $300,000 of impact, probably significantly less and in Q1 or the January 1 day it will be less than $500,000 on a quarterly basis to COGS.

Brad Zelnick -- Credit Suisse -- Analyst

Excellent. Thanks so much, guys.

Operator

Thank you. Our next question is from Ken Talanian from Evercore ISI. Your line is now open.

Ken Talanian -- Evercore ISI -- Analyst

Hi guys, thanks for taking the question. Was wondering if you could rank your success in the enterprise by geo and then separately by vertical?

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

I think I commented -- just getting a little specific I'll probably go back to the comments I made a moment ago that, I thought the US did exceedingly well in the enterprise segment of the business in the third quarter and I am really, really pleased with what they did. But I think going to the next level of details probably where I would pause.

Ken Talanian -- Evercore ISI -- Analyst

Okay. And I guess you mentioned folks are making multiple purchases over time. Are you booking, but not invoicing deals and does that essentially give you some more visibility into future results?

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

I'd still, put that more of the pipeline discussion, if you will, it just moves closer and closer to the close rate. But I'm not sitting on a large backlog if that's the question.

Ken Talanian -- Evercore ISI -- Analyst

Okay, great. Thanks.

Operator

Thank you. Our next question is from Walter Pritchard from Citi. Your line is now open.

Walter Pritchard -- Citi -- Analyst

Thanks. Just a quick question, follow-up on an earlier question on the long-term deferred. Can you help us understand maybe how much of that is macro related with customers feeling better about budgets? And how much of that is a factor of the mix into the enterprise. And in terms of what could drive that to go higher, what would be the -- what will be the drivers from here. It sounds like that's your expectation?

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Yes, I think that if you look at enterprise -- and this is Keith, I'm sorry. If you look at what I'll call the incumbents in the enterprise, you're probably seeing contract terms that are closer to 3 years. We're obviously at 26 months, as I noted, to the extent that we continue to have more and more success in that enterprise segment of the market. I would expect that their buying pattern and we've talked about this before, as such that they're going to want to do 3-year contracts and in many cases, they're going to lot do 5-year contracts. So I think that's where the pressure comes from, its lined up with the success of the push into the enterprise.

Walter Pritchard -- Citi -- Analyst

And then can you comment on the fabric around things like endpoint and email, you haven't mentioned those. It sounds like it's been SD-WAN and switching and so forth and wireless, but how are those products doing?

Ken Xie -- Chairman & Chief Executive Officer

Things are growing very strong and it's a part of the fabric solution we do see a similar growth, is a pretty good growth.

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

I think mail specifically, -- I think we had a very good quarter. I would just put that in the tier, right below access which is analyzer and actually set points, which is an analyzers.

Ken Xie -- Chairman & Chief Executive Officer

Yes, bust also the end point and also the SIEM, and also the acquisition we have for the ZoneFox also will helping end point and the -- but it seem growth.

Walter Pritchard -- Citi -- Analyst

Great, thank you.

Operator

Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to Peter Salkowski, Vice President of Investor Relations for closing remarks.

Peter Salkowski -- Vice President of Investor Relations

Thank you. Gigi. I'd like to thank everyone for joining the call today and letting you know that management will be presenting at the following technology conferences, during the fourth quarter. That will be at the UBS Conference here in San Francisco on November 12; the Nasdaq Conference in London on December 4; and then back to San Francisco for December 6 conference with Barclays. We look forward to seeing all of you at those conferences. If you have any follow-up questions, please feel free to give me a call or send me an email. Have a great rest of your day. Thank you very much.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.

Duration: 59 minutes

Call participants:

Peter Salkowski -- Vice President of Investor Relations

Ken Xie -- Chairman & Chief Executive Officer

Keith Jensen -- Chief Financial Officer, Chief Accounting Officer

Jonathan Ho -- William Blair -- Analyst

Sterling Auty -- JPMorgan -- Analyst

Shaul Eyal -- Oppenheimer & Company -- Analyst

Andrew Nowinski -- Piper Jaffray -- Analyst

Keith Bachman -- Bank of Montreal -- Analyst

Gabriela Borges -- Goldman Sachs -- Analyst

Fatima Boolani -- UBS -- Analyst

Drucker Becky -- Wedbush Securities -- Analyst

Rob Owens -- KeyBanc Capital Markets, Inc. -- Analyst

Melissa Franchi -- Morgan Stanley & Co. LLC -- Analyst

Gregg Moskowitz -- Cowen & Co. LLC -- Analyst

Michael Turits -- Raymond James -- Analyst

Brad Zelnick -- Credit Suisse -- Analyst

Ken Talanian -- Evercore ISI -- Analyst

Walter Pritchard -- Citi -- Analyst

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