Welcome to the 4th Quarter 2018 Arista Networks Financial Results Earnings Conference Call. During the call, all participants will be in a listen only As a reminder, this conference is being recorded and will be available for replay from the Investor Relations section at the Arista website following this call. I will now turn the call over to Mr. Chuck Elliott, Director of Business And In after development. Sir, you may begin.
Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me on today's call are Jayshree Lalal, a Networks' President and Chief Executive Officer and Ida Brennan, Arista's Chief Financial Officer. This afternoon, Arista Networks' issued a press release announcing the results for its fiscal fourth quarter year ended December 31, 2018. If you would like a copy of the release, you can access it online company's website.
During the course of this conference call, Arista Networks Management will make forward looking statements, including those relating to our financial outlook first quarter of 2018 fiscal year industry innovation, our market opportunity, the benefits of recent acquisitions and the impact of litigation. Are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically in our most recent Form 10Q and Form 10 K and which could cause actual results to differ materially from those anticipated by these statements. These forward looking statements apply as of today you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. Also, Please note that certain financial measures we use we have provided reconciliations of these non GAAP financial measures to GAAP financial measures in our earnings press release.
With that, turn the call over to Jayshree.
Thank you, Chuck. Happy Valentine's Day, everyone, and welcome to our fourth quarter 2018 earnings call. In terms of Q4 $195,700,000, while our non GAAP earnings per share grew to a record $2.25. Services contributed approximately 15.5 percent of revenue consistent with it being typically higher as a percentage of overall revenue towards the Q4 end of the year. Our margins in a non GAAP basis were 64.1% influenced strongly by our performance from our cloud titan vertical.
Overall, 2018 gross margins came in at 64.4%. In terms of customer trends, we registered a record number of $1,000,000 customers in Q4, symptomatic of our enterprise vertical momentum. By the end of 2018, we had acquired a cumulative of approximately 5600 customers with Microsoft at 27 percent of total revenue. The combination of an unprecedented year with multiple design wins coupled with the release of deferred revenue due to legal certifications made 2018 a unique one of a kind year at Microsoft. Our use cases are very diverse there.
They transcend classical data center use cases to regional spine routing and DCI networking. So this often makes it difficult to directly correlate network spend to CapEx of server and storage spend. Without these collective one time factors, Microsoft would have likely been more in the normal band of teams of revenue like they have been in prior years. In terms of verticals, Q4 2018 and in fact, throughout 2018, cloud titans represented our largest and strongest vertical. They were represented by our top 5 cloud titan customers.
The modern high-tech enterprise segment is now our 2nd fastest growing and our 2nd largest segment followed by the Tier 2 specialized cloud providers in 3rd place, and the financials and service providers tied for 4th place. Consistent with industry strength, service providers have been somewhat of a low point for us with negative annual growth after a very strong 2017. That said, we are pleased with our increased acceptance of our FlexRoute software licenses, growing 50% from 200 customers in 2017 to 300 customers in 2018. Looking at the 2018 year in entirety, the 2018 international contribution was 28% with the Americas coming in at 72%, not too different from prior years. In terms of new products, Arista delivered a banner year of disruptive products, redefining networking with highly differentiated EOS pack cloud vision management software, and flagship platforms.
The 728075100 series have become the gold standard in 100 gigabit ethernet cloud networking. In 2018, we also introduced substantial software innovations. These included containerization, tracers and analyzers. In particular, we have doubled our cloud vision management's customers and our Any cloud segmentation security software with APIs for AWS, Azure and GCP have indeed been transformational. Undoubtedly, 2018 has been a significant year for Arista with revenue of $2,150,000,000 and an annual growth of over 30%.
With substantial contribution from our cloud vertical. At this time, I'd like to invite Anshul Sedona to recap our cloud titan strategy and really highlight our success here. Anshul?
Thank you, Jayshree. While we pioneered our cloud networking mission with 2 tier lead spine designs, Our customers are now using investor products in a multitude of roles, both within and outside the traditional datacenter boundary which we term as picks of places in the cloud. We are now successfully deployed in many pick rules leaf, spine, bare metal, cluster interconnect, regional spine, pairing spine, private backbone, and extended long haul use cases. Wire speed 256 bit maxic encryption has secured all traffic that leaves the data center facility of our customers. In addition to peace and speed, Arista EOS is strongly preferred for the cloud's mission for the cloud's mission critical use cases due to superior quality programmability via robust APIs and our US SDK.
Our state page real time telemetry delivers world class analytics monitoring and traffic engineering of these networks. All of these compelling advantages have created a collaborative partnership with our cloud customers as a build for next generation architectures with ever increasing workloads. Back to you, Jayshree.
Thank you, Anshul. Effective March 2019, I'm really pleased to announce the promotion of Anshul Sadana to Chief Operating Officer. In this expanded role, Anshul augments present worldwide product management and customer facing functions with platform engineering, manufacturing, and operations. Anshul, as many of you may know, has been a key pillar and contributor at Arista for over 11 years, demonstrating that keen and unique sense of product depth driving our consistent differentiation in the typical Arista way. Please do join me in congratulating Anshul on his very well deserved promotion.
Arista continues to drive cloud area networking, where the future of networking is not siloed to a switch or a router box alone, but in fact, a software driven places in the cloud. As we exit 2018, we believe we hold the number one market spot in 100 Gigabit Ethernet switching share in ports for the high speed data center segment. As I had mentioned last year, scaling the company and the team with a stated goal. We accomplished this many ways including the addition of 2 senior officers to our executive leadership team, John McColl, our Chief Platform Officer and Manny Rivello, our newly appointed Chief Customer Officer. We also successfully integrated our first two M and A transactions this year last year Mojo Networks for cognitive Wi Fi in the campus and Metamako for ultra low latency networking.
Our employee strength increased to 2300 in 2018 from 1700 in 2017, while maintaining our very high bar for top notch talent. What is increasingly clear to me is that Arista's gaining strategic relevance and has a seat at the table with enterprises seeking next generation cloud area networking as a compelling alternative. And with that, I'd like to turn it over to Ida for more financial specifics. Thanks Jayshree and
good afternoon. This analysis of our Q4 and full year 2018 results, and our guidance for Q1 twenty nineteen is based on non GAAP. And excludes all non cash stock based compensation impacts, losses related to our private company investments, charges associated with our recent acquisitions, and other nonrecurring items. A full reconciliation of our selected GAAP to non GAAP results is provided in our earnings release. Total revenues in Q4 were $595,700,000, up 27% year over year and above our guidance of $582,000,000 to $594,000,000.
We experienced good overall demand in the quarter with ongoing strength across the business. Service revenues represented approximately 15.5 percent of revenue, up from 13.8 $900,000 or 24 percent of total revenue, down from 28% in the prior quarter. Looking at the year, international mix remain consistent on a year over year basis at approximately 28% of total revenue. This reflected strong growth in our international and regional businesses, offset by a higher mix of U. S.
Deployments from our cloud titan vertical. Overall gross margin in Q4 was 64.1%, just above the midpoint of our guidance, 63% to 65% and down from 64.6 percent last quarter. This reflected a healthy mix of cloud titan revenues in the period. And as expected, some incremental costs related to the previously announced trade tariffs. While the operations team are making good progress toward mitigating these tariff related costs, we expect to pending completion of the required supply chain changes.
Operating expenses for the quarter were 160.1000000 up from $155,100,000,000 last quarter. R and D spending came in at $104,900,000 or 17.6 percent of revenue, mostly flat to last quarter on an absolute dollar basis. This reflected heavier NRE and prototype spending in the 3rd quarter, offset by ongoing headcount growth in Q4. Sales and marketing expense was $43,800,000 or 7.4 percent of revenue, up from $41,000,000 last quarter, with increased headcount and related sales costs. Our G and A costs remain consistent at approximately 1.9% of revenue.
Our operating income for the $9,500,000 and our effective tax rate was consistent at 21.4%. This resulted in net income for the quarter of $182,200,000 or 30.6%. Our diluted share number for the quarter was 80,930,000 shares, resulting in a diluted earnings per share number for the quarter. $2.25, up 31.5 percent from last year. Now turning to the balance sheet.
Cash, cash equivalents and investments ended the quarter at approximately $2,000,000,000. We generated $296,000,000 of cash from operations in the quarter, reflecting strong net income performance, combined with improvements in supply chain related working capital and increased deferred revenue amounts Overall, we generated $503,000,000 of cash from operations for the year, which included the payment of the Cisco settlement of $400,000,000 in the 3rd quarter. DSO came in at 51 days, down from 53 days in Q3, reflecting the timing of billings in the quarter. Inventory turns were 3.3 times, up slightly from 3.2 percent last quarter. Inventory increased to 264,600,000 in the quarter, up from 216,300,000 This primarily reflects increases in raw materials and finished goods as we ramp the supply chain for new products.
In addition, consistent with last quarter, we maintained a further $14,600,000 of inventory deposits, recording other assets at the end of the quarter. Our total deferred revenue balance $587,200,000, up from $529,900,000 in Q3. Our product deferred revenue balance increased by approximately $18,000,000 in the quarter, reflecting customer acceptance requirements on new products. The 2018 closing product deferred revenue balance was again essentially flat to the prior year and not a meaningful contributor to revenues for the year. There was, however, a shift in the customer makeup of the product deferred, with Microsoft redesigned qualifications, representing a significant portion of the 2017 balance as compared to a negligible amount of Microsoft product deferred
at the end of
2018. Accounts payable were 40 days, up about 9 days in Q3, reflecting the timing of inventory receipts and payments. Capital expenditures for the quarter was $6,200,000. Now turning to our outlook for the first quarter and beyond. We are pleased with our strong 2018 financial performance, with 31% revenue growth and 42% growth in earnings per share and a year over year basis.
As we look forward, we believe we are well positioned with our key cloud customers and remain focused on expanding our presence across our other verticals. Our revenue guidance for the first quarter of $588,000,000 to $598,000,000 represents 25% year over year growth at the midpoint. On the gross margin front, we will reiterate our gross margin outlook of 63% to 65% with customer mix being the key driver where we operate within this range. While we remain cautious in relation to our spending ramp, you should expect to see us make the investments necessary to support the expansion of the business. We believe given some reasonable top line growth, this can be accomplished while maintaining operating margin in the previously discussed approximately 35% range.
With this as a backdrop, our guidance for the first quarter, which is based on non GAAP results and excludes any noncash stock based compensation impact and other nonrecurring items is as follows: Revenues of approximately $588,000,000 to $598,000,000. Gross margins of approximately 63% to 65% and operating margin of approximately 35%. Our effective tax rate is expected to be approximately 21.5% and diluted shares of approximately 81,400,000 I will now turn the call back to Chuck. Chuck?
Thank you, Ida. We are
now going to move to the Q and A portion of the Arista earnings. Due to time constraints, I would like to request that everyone please limit themselves to a single person.
We will now
you.
Your first question comes from the line of Jason Adler with William Blair. Your line is open.
I don't know if you guys, I'm sure you debated this, but, have you thought at all about providing some full year guidance for 2019 in terms of revenue?
Yes, Jason, you can well imagine not only have we debated it, I think you all have debated it. If you look back at our 5 year short history since IPO, we have never provided annual guidance. I think we made an exception once when we felt that consensus was significantly different than our guidance. And therefore, we took exception to that and wanted to course correct and let you know that it was way off our guidance. So I think you can safely assume that since we're not doing that,
that we want to go back
to our normal mode quarterly guidance, and we're comfortable with your current consensus estimates.
Your next question comes from Alex Kirkz with KeyBanc Capital Markets. Your line is open.
Just to, the Jayshree needed here on this Microsoft contribution for 2018. Obviously, that's well above what a lot of us were thinking might happen and maybe you could frame for us how cloud titans finished out for 'eighteen seems like maybe it was pushing 40 percent of revenue. I'd like to have you comment on that. And, and how should we think about cloud titan growth and contribution for the year. I know you're not giving guidance, but just help us frame that because that's a significant upside from Microsoft and sort of our modeling of that.
Yes. So, thanks, Alex. Happy Valentine's Day to you as well. We love you all. And what I would say in general is this is truly an unprecedented one of a once in a lifetime or one of a kind year with micro soft.
We we don't expect that to repeat. We'd love for that to repeat, but we don't expect that. And, and we believe they will continue to be a percent concentration customer in 2019, but we'll go back to a more normal, percentage of our revenue. I think cloud titans as a category did extremely well for us. All 5 major cloud titans that typically contribute to Arista as part of the top 10 customers continue to make important contributions in 2018.
We expect there to always be some shift in balance between the 5 and 2019 will likely be different in the contribution of the cloud titan, but I think you're right in assuming that as a category, we still expect them to be about a third of our revenue in, 2019, and they were higher due to the Microsoft concentration in 2018.
Thank you.
Thank you.
Your next question comes from Samik Chatterjee with JPMorgan. Your line is open.
Hi, thanks for taking the question. And I'm sure you'll congrats on the motion. I just had a question primarily on kind of the prepared remarks that Anshul had about, you're seeing additional users of Arista's product in parts of the data center and outside the data center with cloud customers that obviously has driven some of the strength here. How broad based is that? Do you see more room with some of the cloud items as well as the tier 2 cloud providers to see that expand more and probably that helps you outperform their overall spend on it working even in 2019?
Can you help us think about that?
Certainly. Tom, you're right. There are many of the expanded use cases that we've been growing into, but, as a result of us doing routing encryption, some of the DWDM products, that we have, this for, emitting, colored wavelengths. We are not able to participate in an increasing time. And in the past, you always considered us just as a switch, but we are now able to take on these higher load.
But in addition to that, It's not just a one for one displacement. These are new architectures that are significantly more resilient. The goal many of the cloud titans have and even the smaller cloud companies just at a smaller scale is to not focus on one network that is this mythical 59, but build networks that are parallel out detectures that are highly resilient and be able to do that with our lead spine architectures and some of the new use cases whether it's appearing or or regional fabrics and regional points in spending on the same approach, but expanding to a much wider area within a metro 100 kilometer plus
Okay, got it. Thank you.
Your next sorry, your next question
comes Jim Suva with Citi. Your line is open.
On the tariffs that you made comments on during your prepared comments, and your outlook. Did you mean to say that you're building in the tariffs for your revenue outlook? And was it the 10% rate or the show 25% rate. And is that across all products or just those coming for China? Because I'm sure a lot of products that may be assembled in Guadalajara or Florida could actually contain China parts.
So can you just help us understand how you're navigating through the tariff situation
Yes, let me clarify and I'll pass it over to Ira Jim. What we said in Q3 and we continue to reiterate Q4 is the impact of tariffs, it's still very much there in our costs because many of these components come from China. So even as you move to different contract manufacturers, you can have 2nd second derivative effects, if you will. Erste's response to that was to absorb some of the costs but also have a 3.3 assumptions on the 25% increase since there's still a lot of speculation there. Either you want to add to that on the impact of that?
Yes, I mean, I think it applies to products that have components that are actually tariff, right? It doesn't apply obviously software and optics with more stuff. And again, we're making plans. We have plans, for how we start to remediate this with the supply chain. It just takes time to execute on those plans, right?
You don't move it takes time to affect the supply chain movements, but we're working on that and then we'll share more as we go.
So 25% would be the same methodology as what you did in 10%, I would assume.
Yeah. We haven't really, taught it through or formulated a plan. We're hoping it never happens, but yes, we would apply something similar.
Thank you so much for the details and clarifications. It's greatly appreciated Thank you.
Thank you, Jim. Your next question comes from Ittai Kidron with Oppenheimer. Your line is open.
Congrats, ladies and Chuck. Thanks. Great quarter. I guess I want to go back to where we started again, which is the cloud. Just want to make sure I understand your comments because I mean with Microsoft being 27% on the year, I think you made a comment to the effect that the more normal run rate was the percentage of Microsoft was last year, which was 16%.
And so that implies that about 10% is through product defers and delayed certifications and all of that. And by and since Microsoft is little to no presence in your product deferred right here right now, stripping that out, your core growth in 'eighteen was only 20%, really, outside of the deferred. And I guess I'm trying to think help me think about the titan vertical in general, is that a vertical, that grows below corporate average do you think for the year? Are there big parts in your footprint that you feel would be more competitive on the year and how do you feel about your ability to protect them. And clearly, when 400 comes along, there are a lot of, vendors are making a lot of claims.
And you seem to be at the top of the hill. So clearly you're right at the, right on the target.
Wow, that was a loaded question. Either you want
to clarify
I tried for 3
in there. Yes.
Yeah. You just succeeded. Thank you for the good wishes. Let me let me have Iida clarify some of the yes, maybe let's just talk about
the deferred piece just to make sure we're thinking about same way. I mean, at the end of the day, deferred revenue, product deferred revenue did not contribute to revenue for the year. Right? So if Microsoft, the mix of Microsoft changed, and obviously, that resulted in off having a higher percentage of revenue, right? But also the deferred was backfilled with some other activity.
So when I think about it on an activity basis, you know, Microsoft's activity in the period was, you know, significantly below the 27%. Not back to the teens because we had some good use cases, etcetera, but, you know, significantly below that, 27%. So just to be clear, so when you think about transactional activity in the period, the deferred kind of comes out of that. And we did backfill that deferred amount with some other customers, right.
And to answer your question on growth we obviously don't expect Microsoft to have the same amazing growth in 2018 2019 that we had in 2018. But we fully expect the cloud titan category to grow well, if that makes sense. So I think there'll be puts and takes and other attributors and other customers, be it cloud titans or even some of the tier 2 cloud providers are going to greatly contribute to our cloud group.
Very good. Good luck.
Your next question comes from Jack Wall with Nomura. Your line is open.
Yes. Thank you very much. I'm hoping perhaps to get asked the question that, maybe on many of our minds about webscale CapEx. And, you know, you've touched on it a little bit, today and certainly in the past, but, look, the numbers do seem to be decelerating a decent amount. And I'm wondering if you could help us explain why there is a decent disparity between what the, what the, spenders are up to and your, your revenues.
Sure, Geoff. I'll take a part of the question and I'd like my expert here, our new COO to take the other half. As we try to explain, we're not able to directly correlate service spend with Arista or networking CapEx spend. And the reason is obviously a service spend connects to the first point of a network attach, which is typically a lease switch. But what we're finding is many tiers of leafs and many tiers of spines.
And Anshul gave you some examples of a regional spine, a core routing spine, a WAN spine, a data center interconnect spine, all of those examples and especially the correlation to the first use case we just talked about, which is the server and and first talk of rack switch spent. So the one to one correlation is difficult. However, I think you can make a correlation if the overall spend is declining, then obviously we'll also feel the the impact of that, but it's hard to pinpoint and say a server spend is declining, network spend is declining. It's not one to one. Anshul?
Jeff, I'll add a few things here. Number 1, last year or the last few quarters, there's been significant volatility in memory prices for servers and that resulted in increased CapEx for many other cloud titans and also resulted in a reduction in cloud CapEx for many of the titans that has no impact to networking. So as a result, we're not correlated there. And second, when you look at very large build outs of regions, data centers, facilities, all of that often gets counted as CapEx, but obviously we are just focused on how much networking interconnect you need at different layers or different architectures and hence you will see less correlation in the short term, as Jeshi mentioned, in the very long run, these things can tie back. They're not even associated within that one year.
And hence, the delta, but otherwise, we've done well technically with the cloud titan and we are happy to compete going forward as well. Thank you.
Anshul, do you think that networking is gaining share inside of the overall, web scale CapEx?
I would say networking from our standpoint, not so. I think it's it's very, very similar to some previous years. However, optics is a different ball game and, and as you very well know, 4 slightly more expensive on a per gigabit basis compared to 100 gig or not per gigabit per port and I think that will change some of the equation of what if it is being allocated for but I don't think our correlation gets changed that way.
Thank you, and congratulations on your appointment, Anshul.
Your next question comes from James Faucette with Morgan Stanley. Your line is open.
Great. Thank you very much. Anshul, I wanted to follow-up on your mention of 400 gig and that coming to market and implementation later this year and through 2020 beyond. And as you're looking at that, what do you think the the appetite is from your customers to, mix and match 400 gig with existing 100 gig plant. And I guess I'm wondering how much opportunity do you see for footprint share shift among in your customer for that?
And secondly, maybe as you're talking about that, maybe you can also talk through kind of what the use cases are for 400 gig that you think will at least start things going.
James, I'm gonna kick it off and then Anshul will get into detail. I think one of the things we have said consistently is that 104100 gig mix and match is going to happen frequently. And in fact, with the exception of the cloud titans that are going to push us more on 400 gig, The mainstream use cases we see in in 2019 are still heavily favored by 100 gig. And even as you go to 2020 when the optics become more available, I think you're going to see much more of our combination. And that's going to favor Arista because of our incumbency and leadership position in 100 gig Anshul?
Absolutely. Thanks, Jayshree. So, so just adding on to what you just heard in networking, you do not introduce a new speed. That's not backwards compatible with the existing installed base. Otherwise, you'll just never get to get it to work.
Which is how ipv5 died.
What is ipv5?
But, if you look at, 400 gig in the cloud data centers and the way the architectures are going on, the hyperscalers are hyperactive with the NextGen design. And they all have their own problems to solve for different use cases, whether it's public cloud or storage or video or caching and so on. You can't just touch one intermediate layer and say I'm done with my 4 100 gig upgrade, you have to upgrade end to end So it'll be a slow transition and hence the interop is important. I would say interop, of a 400 gig uptake back into a DR1 QSFP28 is going to be very, very important even for cloud customers. That's the only way you connect back to the installed base.
But because now you have touched multiple layers, takes a long time, several quarters to several years to actually get that update done.
Your next question comes from Rod Hall with Goldman Sachs. Your line is open.
I wanted to start off, I guess, and just since we've talked a lot about data center, just ask about campus and see if there's any update on that, if you guys have any mile phones that you might be able to, you know, give us in terms of trials, things like that, how it's going. And then secondly, I just wanted to clarify your comments on seasonality around services. That was quite a bit higher than we anticipated. And I'm wondering, are you saying that that's more of a normal seasonal progression of services looking forward or is that an abnormal, quarter that we're looking at here? Thanks.
Yeah. Let me take that one first just to I mean, I think the the 15 and a half is probably high. Right? It's a q 4 tends to be a strong renewal. Quarter and there's some recognition of revenue that comes along with that.
So I think back in the 14%, maybe 14% change is kind of probably a better average for the year, is how you should think about it.
Question, it's too early for revenue. I think it'll be more material in the second half, but, we've seen an extremely strong desire to have a viable or innovative, to the incumbents in quality and simplicity and cognitive capabilities and automation. And I'm going to let our new chief customer us, so many of others speak to it soon. Manny?
Thanks Jayshree, Rod. Good to talk to you. So I think Jayshree classified it correctly. It is early days, and we see this being material in the second half of of twenty nineteen, but the initial acceptance has been really well received by the customers. And I think there's 2 categories you can put customers in.
The first is our existing installed base. And that installed base is looking to extend EOS across their infrastructure into the campus, driving 1 management plane, cognitive management plane, 1 set of telemetry one EOS. And they're really looking to for simplicity, they're looking for agility, they're looking for scale, and they're looking for quality. Second type of customer we're running into are customers we haven't done business with that know we're approaching the campus space. And those customers are really looking at us as an alternative because of fatigue.
They're seeing in the market segment, basically 30 years of lack of innovation, 30 years of stagnant architectures, and more and more boxes being pushed out instead of a unified architecture. So we're seeing great traction with those customers early days But like I said, it's early days. We've got to round up the portfolio and bring that to the customer base, but there's a lot of excitement there also. And then just to give you examples of wins, I mean, we had various wins throughout the quarter in the campus. 1 was a $1,000,000 account, which is a multinational beverage company where we basically were driving our campus solutions into that and drove great success into that.
And we expect to see expansion going on there. And we've also had lots of wins where we began to integrate our spline architecture inside the use cases, and again, for the same reasons, scale, quality, fatigue, etcetera.
Your next question comes from Paul Silverstein with Cowen And Company. Your line is open.
Right. Thank you. Jayshree, you know how much you love to be pinned down. So that's big one.
Depends by. Thanks, Paul. Happy Valentine today to you as well.
Right right back. Gotcha. So for the 1st quarter and the 25% are there about year over year guidance that you gave? How do you get there? Could you help, could you help break it down by customer?
I'm not asking you about individual customers, but in terms of customer verticals, what drives that growth? And then I have a follow-up question. Appreciate it.
I think I expect to see a more normal, concentration of customer verticals, I think all 5 will be represented in double digit cloud titans will, I think, continue to be 1. If I had to guess, I would say enterprise will continue to be 2 again, and then it's hard to forecast between 3, 4, and 5. Well, I guess Does that make you happy?
No, not exactly. What I'm trying to get at is I trust it goes without saying or maybe it doesn't, that the customer verticals 2, 3, 5, your cloud specialists, especially your enterprise, service fighters, etcetera, that collectively, you're expecting the growth rate from that group of customers, I. E. The customers other than cloud titans. To increase and you're expecting growth from cloud titans to moderate.
Is that a fair assumption?
Yes and no. I'm expecting growth from Microsoft to moderate, but I haven't said I'm expecting growth from the cloud titan vertical to moderate.
So you're not expecting growth from your other cloud science to moderate? And from the cloud side, you
go to
I'm excited to say that. No, but I think it's fair to say it will moderate with Microsoft given the once in a lifetime unique year we had here in 2018.
Got it.
Thanks. With the personal Microsoft, we feel very comfortable of our growth in all five verticals. I think that's right. And Paul, we can chat about this more, but we should probably allow the next question.
Can I just quickly ask you as a follow-up Is there anything unique about the first quarter relative to the rest of the year?
No more than the normal seasonality, right? I think you know, it's always a quarter that, you know, tends to be flattish off of Q4. I don't know if there's anything else particularly unique about Q1.
Appreciate
I think there's more similar, yes, I think there's more similarities to Q1 with prior Q1 than uniqueness.
That's all I need. Thank you.
Your next question comes from Sami Badri with Credit Suisse. Your line is open.
Hi. Thank you. Could we just take a few moments maybe just to discuss what you're seeing with service provider? Because the one thing in higher sector seems to be very hyped up about its 5G. And you're seeing it on the RAN side, but there seems to be a big disconnect when we get into the equipment side of the spec room.
Can you just kind of walk us through when you think SP spending towards equipment will start to ramp back up? And is this a back half of 'nineteen event or is this a 2020 based on your purview at this juncture?
Okay. I'll, Sam, I'll take a crack at it. And I think many in Anshul may help me as well. Look, I think given our very small presence in a service provider, we don't believe we are affected by macro trends and in our view, at least the influence of Arista gear is 5G dependent because we're really a backhaul for IP routing and ring switching and routing together and providing the scale of route and IP tables and ACLs that no one does. That said, I don't think we think 5G is really a move away.
4 100 gig is 20 I think we think 5G is 2021. So from our perspective, we've got upside in, service provider because we had a very strong 2017 We're disappointed in 2018 and that gives us a chance to grow faster in 2019. Seeing tremendous activity, both in the U. S. And we have put more emphasis in international theaters.
Manny, maybe you want to speak to that?
Yeah. No, I think, just to add to that. And the use cases that we play in a service provider, whether it be telco cloud and FDI or tiering. We're doing quite well at executing across the globe in various tier 1 and tier 2 operators. In other use cases, the portfolio continues to round itself out, except features to cover those use cases.
But as Jayshree pointed out, we've also made investments in 2018 for better coverage, both on the account manager side and on the SE side to represent those tier 1 operators. We're getting more advanced as it pertains to RFPs and proof of concept. So we think that will bode well as we enter 2019 and beyond.
Got it. Thank you. Thanks,
Amy.
Your next question comes from Alex Henderson with Needham And Company. Your line is open.
We appreciate it. I wanted to ask a question relative to, 2 dynamics, and see if you could play them off against each other. So we're definitely hearing a lot of conversations about, slowdown in, server, investments based off of, product cycles, at Intel. As well as some of the other, cycles that are going on that suggest a slowdown in cloud in the first half of the year and are reacceleration in the back half of the year. So part of the question is, you know, are you seeing that kind of dynamic as well?
And then the other side of it, there's a countervailing force, which we're hearing that spending on a 100 gig is expected to double year over year in terms of port sales. So to the extent that we're seeing a doubling of a 100 gig, are you gaining enough share in a 100 gig as a result of your dominance in that space which I think is 2x the share of your overall market share. And does that offset the the dividend demand in the first half and web 2.0 due to those product cycles.
Sure. Absolutely. Alex, great questions. And in terms of CapEx for the large cloud titans, We certainly don't have visibility yet into second half. We would love them to forecast accurately as you very well know.
On the first half, because we are in so many divorce use cases, we are getting a little bit decoupled in the short term from their exact server spend. They might be buying fewer racks for now, but they are still doing DCI build out other things and so on. But at the same time, obviously, if they spend more in the long run, we could it. Now to your point on 100 gig spending or 100 gig ports are doubling and I would emphasize actually 100 gig ports that are doubling not the spend, is because some of the next generation technology is now starting to show up in the market, including some of our products, which are really being used, not as 400 gig, but more cost effective 4 by 100 gig. And that allows months to get many more ports than what they used to be in the past, but that doesn't change the revenue dynamics significantly.
It just lowers the ASP and increase the port count.
But does it change share is the question?
That'll depend on our execution, Alex. We've held on to the number one position for years in a row. Hopefully, this year will be our 3rd.
Your next question comes from Aaron Rakers with Wells Fargo.
On the print. You know, I want to go back to the router market. You mentioned in the prepared remarks, you've gone from 200 to 300 flexroute customers it sounds like one of your major silicon providers has a major release starting to ship in volume Jericho 2 looking towards the mid part of the year. Which is very focused on the service provider market. So I'm curious as we look out over the next 12 plus months, is there a natural expansion story in the router functionality that expands your opportunity set in that incremental growth driver going forward.
Thanks, Aaron. I think it's a really good question. I believe we have a national expansion even before Jericho too. Which has had to do with a lot of our FlexRoute features and the 50% growth of our customers from 200 to 300 So at least in 2019, I see that the more immediate success will be not necessarily waiting for the next generation of silicon But really going into these 200 to 300 customers and enabling greatest success, many of who are service providers. Now after that, the Jericho 2 cycle, which really hits in the second half of the year, Anshul is confirming, I think we can have a multi year, success in routing in 2020 and beyond with Jericho too.
And I'm just kind of curious, how
much how big do you view that total addressable router market today And how much do you think
is that? It's a tough it's a tough one to answer. The total market is 8,000,000,000, but I think our TAM is more like 2 to 3. It's a good guess but some of them end up being very specific traditional legacy MPLS traffic engineering boxes. Avista doesn't play in that.
But as they look to come in as, Manny was describing into the spine peering and interconnect and NFV and, telco cloud Arista is a player to combine the universal spine switching and routing.
Your next question comes from Simon Leopold with Raymond James. Your line is open.
I wanted to see if we could maybe take a look at getting some thoughts on 2020 in particular. If I characterize your base business as as put put this side and thinking about 3 growth engines, campus switching, routing, and 400 gig switching, as the incremental parts, how do you see those 3 in terms of rank order contributors in 2020? Thank you.
Wow. You you get the prize for the tough questions so far. Right up there with Paul. So Simon I'm honored. We'll give it our best, but this is purely a forecast.
I think if you look at TAM, The largest TAM of these 3 campus routing and 400 gig is campus. And it's also the most underserved by any alternative competitor because it's it's so deeply embedded by incumbency. So we believe our largest strength and opportunity is campus and our largest pressure to execute. Is also campus if I put that in that way. And then I think, if I had to split the 2, I would say routing second and 400 because I think writing really doesn't come in 400 gig doesn't really come into play in a huge way until 2020.
Great. That's very much what I was looking for. Thank you.
Thank you, Simon.
Your next question comes from Eric Slabiger with JMP Securities. Your line is open.
Hey, this is Michael Berg on for Eric Superger. Congrats on a great print. Just wanted to have a quick question on international. Could you provide any color around what may have caused the weakness there? I mean, was it around international cloud spending or enterprise spending, what are you thinking around international in the quarter?
Yes. I mean, the mix between international and U. S. In any given quarter is going to be pretty volatile, right? And the if you look at it for the year, which I think is kind of more interesting and you peel it back, you've got good growth in the in region businesses.
And then just a heavier deployment of cloud in the U. S. Than what we saw last year, right? You'd seen some pretty heavy international cloud activity last year this year as more U. S.
Focused, right? So I think that's probably the biggest driver. If I strip all that out and look at the growth in the region, those businesses are growing faster than the from the carbon average. I think Manny, if you want to chime in as well. Yes, I
think what I'll add on top of that, and I think Jayshree said it, I mean, you just said it well. Is we are actually seeing, great, and we're making significant investment in international markets from a headcount perspective. So we're balancing that out fairly nicely. Approximately 40% is going to international headcount. That's a little higher than what you're seeing from a percentage of business But what's more interesting is the net new logos where we are seeing a lot of new wins there.
Approximately half of our net new logos are coming out of the international market. So we're having great traction there, great acceptance of the technology. You could argue in some of the international markets, they're a little behind in the adoption of finally architectures, but they're coming along quite nicely, and we think that that's a growth engine also for the future.
Okay, great. And then a quick follow-up on the Microsoft piece. I know that you mentioned that if you normalize it, it's closer to the 16%. But if I'm thinking about the deferred revenue piece being a big contributor, wouldn't that, lead it to be closer to 8 18, 20% or how can I think about, how deferred contributed to Microsoft in the year?
Yes, I mean, I don't know that I'm going to put specific numbers on it, but I mean, I think it was a it was a good strong Microsoft year just from an organic business perspective, and it would have been, well, ahead of the 16% in any case. But again, a chunk of what the 27 came from the deferred.
And I think the other way to think of this, is that in many ways, we we did get 6 quarters of business in four quarters, right, because of the deferred and because of the legal certifications. So It was unusual in every manner, right? Not just the deferred, but the legal certifications, the new roles, and the time at which we could recognize it. Even though the activity began much before.
Okay. And then I think someone asked this before, but Is it fair to assume that the cloud, cloud titans vertical was, you know, closer to 40 or even higher percentage of total revenue for the year, given the high Microsoft contribution
I think around there is a fair guess.
Okay. Awesome. Well, hey, congrats on a great quarter again and thank you for the time.
Thank you, Eric.
Your next question comes from Steve Milunovich with Wolfe Research. Your line is open.
Great. Thank you very much. Could you comment a bit about expenses going forward? You had a year over year acceleration in marketing, a deceleration in R and D, which you talked about a little bit. What sorts of growth rates or percentages of revenue can we look forward to in your longer term target of 32% operating margin what's the time frame for that?
Is it going to be within my lifetime?
Yeah. I mean, it depends how long you live. Yeah.
Really, it's pretty long to
update the the long time the long term model, and we'll we'll we'll take the opportunity do that at some point here. I mean, I think what we're seeing is in the near term timeframe, but plus or minus 35 percent operating margin is a good way to think And that allows us to see some movement of gross margin quarter over quarter and do make the investments that we want to make, right? I mean, if we're Yes, we're still in a situation where we're growing the top line at the rate that we're growing the top line at. It's letting us that we of revenue that it has been. And maybe we get a little bit of leverage on the R and D, but that's not going to be the same every quarter and it's not significant, right?
And I think think about the 35%
Your next question comes from Srini Pajjuri with Macquarie Securities. Your line is open.
Thank you for taking my question and congrats. I'm sure congrats on a good great quarter as well. Just one clarification maybe for Iida, would it be possible to give us, you know, what Microsoft was in in Q4 or even second half versus first half as a percent of sales?
Yeah. We're I don't think we're going to do that, right. I mean, if it's it moves around, it's, yeah, it's not really helpful to start to try and do that on a quarterly I think the annual number is really the way to think about it and then take some off the top for the deferred for the release of the legal related certification stuff at the beginning of last year. And so think about 16% was our norm for the last couple of years, and it was a good strong year for Microsoft on top of that just from a transactional business perspective.
Okay. Then maybe a follow-up, I guess, on 400 Gig Jayshree, I think Cisco yesterday said, they're expecting volume deployments on middle of this year, and you seem to think it's more likely in 2020. I just want to understand why you think it's a little later than Cisco. I know Juniper said it's all 2020, but I'm wondering why there will be a difference between their timing and your timing?
Well, I think we actually, Srini sell to some of the world's leading early adopters of 400 gig. And where Anshul and the team are seeing traction is in the the cloud titan vertical. We work with a multitude of optics vendors and we see that as the longest pole in the tent. So while we absolutely expect to see early trials in the second half, we would be responsible to tell you we're going to see large market in the second half. So I guess you could chalk it down to our responsibility.
If I can add something here, we should not confuse product availability versus high volume deployment. These are 2 different things.
Very good point. And our products have been available since the beginning of the year.
Your next question comes from James Fish with Piper Jaffray. Your line is open.
I guess, a lot of questions have been asked already, but, maybe asking it a different way. Where are you hearing from hyperscalers on the 400g optics and potential mix between the OSFP and the QSFP. And, and secondly, on 400 B, competitively, do you fear kind a white fox offering more, or do you fear, like, the Ciscos and Junipers of the
world? Thanks.
Wow. That is two unique questions.
So, James, in terms of first optics on 400 Gig OSFP versus DD, in the cloud titans, there's a lot of interest in moving the world forward, and planning it out many, many years in advance so that you can actually move to the next generation. So in fact, it's the hyperscalers where there's a lot of interest in OSFP. At the same time, we are cognizant that some of the customers need, DD based products. We will build those as well, but as you may recognize, D. D.
Has a short life cycle because after the fifty-sixty cycle, it it currently works. So then the world has to move forward. We'll do both. We believe, there'll be a very healthy mix and a good attach rate of OSFP here. With respect to the white boxes, we've touched on this many, many times.
We are very competitive in this market. And, as we mentioned before, we're not really customers are not looking to just buy a cheap white box and then do something cool with it. They want to solve real world problems. So they are codeveloping with us and partnering with us to solve these problems, taking parts or all of EOS and building on top of that. And as you can see, our business is very healthy with them and this part of the noise, we feel good about our position there.
And I think the noise in general has reduced a lot. We haven't we don't hear what it bugs from our customers very much anymore. So to answer your question more directly, usually a competitive position against a specific vendor like Cisco rather than the description or discussion of a white box.
Your next question comes from Hendi Susanto with Gabelli. Your line is open.
Thank you for taking my question and congrats Anshul and Mani. J3 and Anshul, how should we think about Mark opportunity and dynamics in 2019. Like first specifically about macroeconomic uncertainties, Cisco stated there was no change in demand and no impact from macro uncertainties in the last quarter. I'm wondering like how similar your experience was in Q4? And then second, how do you characterize market opportunity in 2019 versus 2018?
Are there more similarities or are there more new opportunities versus 2018 that investor and analysts should think about.
Okay. Thanks, Hendi. Well, I would say Arista has not seen any macroeconomic uncertainty either in Q4. I think, obviously, we're not a bellwether here. But as far as our customers have gone, have been signaling to us, our enterprise momentum hasn't been stronger.
And we continue to see strength there in Q4 and we look forward to that strength continuing in 20 in. I'm gonna let Anshul answer the 2019 trends.
Sure, absolutely. Thanks, Heidi. We haven't seen much of a big change in terms of, perception I think people are certainly worried that if there's a slowdown, there will be a correction. Our customers do, talk about it, but nothing material has happened so far. I think I've watching these trends very carefully.
Beyond that, the actual opportunity hasn't changed for us. It's a radars stand. We are catering to and we look at enterprises, there's still a very, very healthy opportunity ahead of us. The same is true in the tier 2 and the specialty cloud providers. As well as financials and and, even more expansion possible for us in future NSPs.
So we still feel very good about the opportunity. We believe, the market is, has multiple players, but we are a very, very strong competitor in the space and hence, the opportunity to grow.
Your next question comes from John Marchetti with Stifel. Your line is open.
Thanks very much. Jayshree, I was wondering if you could just spend a little bit of time here on the enterprise market. You know, we spend a lot of time on where the cloud titans are in terms of their 100 gig adoption and maybe they're shipped to 4.
I was wondering if maybe
you could spend just a minute or 2 discussing sort of how you're expecting that enterprise market to kind of follow soon and where you think that market is of overall with its adoption of 100 gig?
Well, thanks, John. I'm actually glad you asked this question because, yes, we tend to focus on the cloud titans a lot, but one of the things we're seeing, it is one of our 2nd largest and fastest growing vertical. And there's a very strong interest in bringing those same cloud principles into the data center in the enterprise. And it really comes in 3 flavors: first, how to build a private cloud with, you know, at least spine architectures and scale out the same way, albeit in smaller scale. The second is to to bring some of the cloud management principles, the cloud vision, bringing change control automation network wide analytics, etcetera.
And the 3rd is the hybrid cloud. No company is a better position than Arista as we have deployed in both the public and the enterprise in bringing those 2 together from a workload point of view. So the combination of our VUS router with the right APIs to multiple public cloud vendors has been very transformational and well received. And finally, of course, the 4th which I don't want to over talk, but will really come to play in the second half of this year as the campus. So when you look at our whole pinch to pitch transformation, there's at least 4 different use cases in the eyes that are exciting.
Thanks. And maybe just as a, as a quick follow-up there, you know, given that that they're looking a lot of these different applications or use cases for the first time. Did that lend itself to maybe some additional service sales or you know, almost from a consulting type of of standpoint as you look to to to help them migrate, to these types of solutions?
I think we definitely, Arista has looked at to be more of a consultative approach, provide the right training. And the professional services varies. We often park with someone or they look for us to come in. Manny, I don't know if you have more to add to that. We don't see a pattern yet.
No, I mean, in general, it's an education for the customer base. As they transform their infrastructures into a much more, digital, framework, they're going to need these modern data centers, the product providers. So if those solutions are proven and tested and we could deliver those, then the delivery of that solution to the customer either comes through development effort, education training that we can provide and or through our professional services and or our partner network. That could offer those services. So we have a lot of flexibility there, and we're seeing that pretty well accepted across all three of those spectrum.
Thanks very much.
This concludes the Arista Q4 2018 earnings call. You for all the good questions and for the opportunity to highlight our financial results and corporate achievements for you. I also want to mention that we have posted a presentation which provides information on our fiscal results, which you can access on the Investors section of our website. We look forward to continuing the conversation with you during the quarter.
Thank you for joining ladies and gentlemen. This concludes today's call. You may now disconnect.