Welcome to the Second Quarter 2018 Arista Networks Financial Results Earnings Conference Call. During the call, all participants will be in a listen only Instructions will be provided at that time. 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 Investor 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 Yulal, Arista 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 second quarter 2018. If you would like a copy of the release, you can access it online at the 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 our market opportunity, the benefits of recent acquisitions, and the impact of litigation, which are subject to the risks and in certain 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 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 on this call are expressed on an on GAAP basis and have been adjusted to exclude certain charges. We have provided reconciliations of these non GAAP financial measures to GAAP financial measures in our earnings press release. With that, I will turn the call over to Jayshree.
Thank you, Chuck. Thank you everyone for joining us this afternoon for our second quarter of 2018 earnings call. I am pleased to report that we had a record Q2 surpassing the 500,000,000 mark. We exceeded our guidance with a non GAAP revenue of $519,800,000 as we grew more than 28% year over year despite tough comparisons from 2017. Our non contribution of our total revenue, while the rest of the international theatres performed reasonably well.
We delivered non GAAP gross margins of 64.5% in our dynamic industry, exceeding our forecast due to customer mix. In terms of vertical trends, Our top 10 customers included all 5 verticals. Cloud Titans contributed strongly in Q2 and ranked as our number one vertical. Followed by enterprises and cloud specialized providers at number 2, and financials and tier 1, tier 2 service providers tied for 3rd place. Our new customer acquisition continues to be brisk and our $1,000,000 customers continue to be healthy as well.
And we're especially pleased with the software and services acceptance with cloud vision customers. In terms of new introductions in Q2, we had an Analyst Day on May 7, 2018. Arista introduced our formal entry into the campus market with our spline products and the cognitive management plane architecture. And so you might be thinking, why did we enter this market? And the simple factors our customers have been asking us to do so some time.
They have been deploying Arista products and campus use cases already to take advantage of Arista EOS quality and our state driven sofa architecture. Overcoming the legacy 3 tiered model from the market incumbents, the Arista X3 spline is another example of disrupting the status quo. We are collapsing the aggregation and co layers into a single tier. Chassis and fixed form factors are now available in Q3 2018 with wire speed layer 2, layer 3 switching rates and a cognitive suite of campus controls such as high resilience, secure segmentation and scale for different Ranger protocol for L2, L3 and L2 over L3. The Arista cognitive campus also works with a diverse suite of Edge devices, including 3rd party.
Today, Arista is also announcing its 1st acquisition module networks to expand into the Cognitive Wi Fi Edge. We believe the cloud managed cognitive WiFi is a very natural complement to our next generation campus and cloud networking portfolio. I want to take this opportunity to warmly welcome Rick Wilmer, the CEO of Mojo Networks, and Praveen Pagavath, founder and CTO of Mojo, as well as the entire Mojo team to the Arista family. This transaction will close in Q3 2018, and I expect this to be accretive in 2019. At the core of our campus strategy is our powerful cognitive management architecture.
Whereby the network auto discovers connected devices, applications, and streaming data. CMP based on cloud vision assesses profile based parameters such as configureless bandwidth packet size, inter packet gap, open ports, white list, etcetera. I could go on and on, but I would like to invite our chief guest the Chief Technology Officer of Arista, Ken Duda, and our Senior VP of Software Engineering to say a few words. Ken?
Thanks, Jayshree. With the cloud vision cognitive management plane, Arissa is fundamentally advancing the way networks are operated and managed. Cloudvision gathers all network state to a single place, keeping historical information as long as a customer wants it, and analyzing and learning from all of that state. Operators enforce network wide policy centrally and cloud vision autonomously ensures that policy is implemented correctly across the entire network. Flagging any compliance issues and creating workflows applied on approval to bring devices back into full compliance.
What sets cloud vision apart is the confidence that it brings, confidence that things are working and working the way you expect. So you can now imagine how delighted we were to integrate module network technology. Mojo pioneered cognitive Wi Fi, in which Wi Fi state streams from access points to a centralized open source data store for analysis. By itself, it's a big help for network operators, helping with capacity planning, upgrades, troubleshooting performance issues, But in combination with CloudVision, it's even better. We can now extend CloudVision's reach enterprise wide from the Wi Fi client across the campus to the enterprise data center and all the way to the cloud.
This gives cloud vision customers a single pane of glass, through which they can see everything going on end to end through their network. They can use one system that both ensures security compliance for physical switches and also generates alerts about WiFi connection issues. They can apply the same security policies to networked whether that Edge is wired, wireless or virtual. They can monitor for unauthorized or misbehaving IoT devices, again, wherever and however connected. But at a higher level, our campus strategy is very simple.
Bringing the benefits of Arista's data center switches to the enterprise campus, and these benefits are high quality trouble free devices, a single software image across all switches for consistency and simplicity of operations and cognitive management, lowering operational cost through automation and providing advanced compliance visibility and telemetry features.
Thank you, Ken. Your passion and enthusiasm on technology is always infectious. So I want to get that CMP right now and install it at home. We are witnessing an architectural shift in the campus that really similar to the data center migration. When you look at what we're doing, it's an important step towards taking these silo places in the network or pins of yesteryears to the cloud first strategy with PIX or places in the cloud as an important evolution to our customers.
During this time, we remain committed to our HPE Aruba Partnership for mutual customers and to also promote open and multi vendor interoperability. In Q2, we also introduced an exciting programmable product, the Arista 7170. The new 7170 series is bringing a new generation of programmable pop tackett processors for 64 ports of 100 gigabit ethernet, all in a single fixed leaf form factor. Using a new merchant silicon vendor barefoot networks, to make this possible. Traditionally building such a chip that was both programmable and extremely fast wasn't so doable with our trade offs, but with the Arista 7170, this defies tradition.
It's integrating a suite of capabilities that previously ran on a host or VM or NIC into a single one rack unit switch. Examples of this programmability include advanced layer 4 to layer 7 features, tunnel termination, traffic filtering, network address translation and deeper packet inspection. The 7170 embodies Arista's EOS cognitive features at scale with modern P4 language. Use cases include tunnel scaling and multi tenant data centers, applying network security segmentation, real time network telemetry, time stamping visibility and packet capture. As I look at our progress in Q2 twenty eighteen and in fact step back and reflect on the first half of twenty eighteen, I'm pleased by our progress on many fronts as we have moved from point products to software driven cloud platforms with best of breed capabilities.
We're gratified by the continued recognition from Gartner as a leader in their Magic Quadrant for data center networking. For the 4th consecutive year, as well as Forrester's FCN wave leader in the hardware category with the top score. Arista was also recognized by Forbes as a Global 2000 company for the first time in June 2018. Clearly, we're one of the fastest growing networking companies in recent history achieving $2,000,000,000 in annual revenue run rate with profitability metrics. I'm definitely excited by our future ahead.
With that, I'd like to turn it over to Ida, our Chief Financial Officer, For more financial specifics. Peter? Thanks, Jayshree, and good afternoon. This analysis of our Q2 results
and our guidance for Q3 2018 is based on non GAAP. And excludes all non cash stock based compensation impacts and impairment of our private company equity investments and legal costs associated with the ongoing lawsuits. A full reconciliation of our selected GAAP to non GAAP results is provided in our earnings release. Total revenues in Q2 were 519 800,000 up 28% year over year and above our guidance of $500,000,000 to $514,000,000. We were pleased with overall demand in the quarter with ongoing strength from our Platts Titan vertical.
Service revenues for the quarter were approximately 14.4% of revenue, up from prior periods and reflecting higher renewal activity. International revenues for the quarter came in at 142,000,000 27% of total revenue, down from 33% in the prior period. The lower international mix on a quarter over quarter basis primarily reflected the timing of some cloud deployments and the inclusion of some larger in region EMEA deals last quarter. Our international base is still relatively small and will experience some volatility on a quarterly basis as the business develops. Overall gross margins in Q2 was 64.5 percent, up from 64.4% last quarter, and above the midpoint of our guidance of 62% to 64%.
This outperformance versus guidance primarily reflected increased leverage on our fixed cost base in the quarter. Operating expenses for the quarter were $143,900,000, up from $137,400,000 last quarter. R and D spending came in at $92,300,000 or 17.8 percent of revenue, up from $91,400,000 in the prior period with increased headcount and related expenses. Sales and marketing expense was $39,900,000 or 7.7 percent of revenue, up from $36,200,000 last quarter, reflecting increased marketing and demo related expenses. Our G and A costs included some legal and accounting fees associated with the Mojo acquisition announced today.
Our operating income for the quarter was $191,200,000 or 36.8 percent of revenue. Other income and expense for the quarter was a favorable $6,900,000 and our effective tax rate was 21.4%. This resulted in net income for the quarter of $155,700,000 or 30 percent of revenue. Our diluted share number for the quarter was 80,800,000 shares, resulting in a diluted earnings per share number of $1.93 up 44% from the prior year. Legal expenses associated with the ongoing lawsuits came in at $3,600,000 for the quarter.
In addition, we recorded a $9,100,000 impairment of our private company equity investments, reflecting evaluation adjustment based on our recent funding round. Both of these amounts are excluded from the non GAAP results discussed above. Now turning to the balance sheet. Cash, cash equivalents and investments ended the quarter at approximately 1,900,000,000. Generated $130,600,000 of cash from operations in the June quarter.
This reflects strong net income performance offset by changes in working capital requirements. DSOs came in at 46 days, up from 39 in Q1 reflecting the timing of billings and collections in the quarter. Inventory turns were 2.7 times, up from 2.2 in Q1, and inventory decreased to $245,400,000 in the quarter, down from $268,100,000 in the prior period. This reflects reductions primarily in finished goods as we continue to optimize our supply chain. In addition, we maintained a further 25,300,000 of inventory deposits recorded in other assets compared to $24,000,000 last quarter.
Our total deferred revenue balance was $448,600,000, down from $456,100,000 in Q1. Product deferred revenue declined by $15,000,000 in the quarter with customers completing final 945 related qualifications. At this point, we believe we've reached a somewhat normalized level of product deferred revenue. And while the underlying transactions will cycle on a quarter by quarter basis, the magnitude of the balance should stabilize. Accounts payable days were 26 days, down from 38 days in Q1, reflecting the timing of inventory receipts and payments.
Capital expenditures for the quarter were $6,700,000. Now turning to guidance. As we look forward to the remainder of 2018, we believe that we are well positioned to benefit from the continuing growth in cloud networking across our customer base. Our revenue guidance for the third quarter consistent with our previous outlook, which called for mid-twenty percent revenue growth for the second half of the year. The operations team is currently working to understand attempt to mitigate any potential gross margin headwinds related to the trade tariff announcements.
We would ultimately look to pass on any un remediated costs. To customers. We announced earlier today that we're acquiring Mojo Networks. This represents a small but strategic transaction, which we expect to play an important role in our overall expansion into campus. We are just beginning the business and accounting integration and the acquisition will be recorded in our financials for the third quarter.
With this as a backdrop, our guidance for the third quarter, which is based on non GAAP, and excludes any non cash stock based compensation impacts and any legal costs associated with the ongoing lawsuits is as follows. Revenues of approximately $540,000,000 to $552,000,000. Gross margin of approximately 63% to 65% operating margin of approximately 32 percent to 34 percent. Our effective tax rate is expected to be approximately 21.5 percent with diluted shares of approximately $81,100,000. Please note that based on our current outlook, we expect costs associated with the ongoing lawsuits to be approximately $6,000,000 for the quarter.
I will now turn the call back to Chuck. Jeff?
Thank you, Ita. We are now going to move to the Q and A portion of the Arista earnings call. Due to time constraints, I'd like to request that everyone please limit themselves to a single question.
We will now begin
you.
Your first question comes from James Fish with Piper Jaffray. Your line is open.
Hey, congrats on the quarter here and congrats on the deal as well with Mojo Networks. I'll just keep it to one question as requested. I guess maybe just to start off Can we talk about what you're seeing in terms of traction in the campus and where we are with the enterprise investments and sales build up for the campus? Thank you.
Thank you, James. As you know, if you are here in May, we announced the vision And we said products would really be in second half. And as you rightly point out, a lot of the interest in the campus is directly tied to enterprise customers. Many enterprise customers have already been using us in the data center with our EOS and want to have a common spine line architecture for both their campus edge and their data center edge. So those products are rolling out in Q3.
So we're in very early sampling with customers. And I don't expect material engagement with them in the second half, but I expect a lot of customer interest. And really the material impact of that will be next year. So far, it's very promising. There's a lot of interest.
There's a lot of also commonality in protocols, because the work we're doing with VxLAN, EVPN, BGP protocols, plain old fashioned VLAN with m lags, looking back in what we did in the early years are all applicable in the campus. And, we're also working closely with HPE and their PoE switches and the Aruba wireless as well to make sure they work with us line.
And on the investment side of that?
What was the question? Yes. No, we're just starting. Manny Rivelo is driving a lot of this investment. It's part of our sales and marketing investment in general in expanding both the channels and putting more presence in the enterprise.
I would say every region is making a strong investment there. And, we we've already started that activity since May.
Got it. Thank you.
Your next question comes from James Faucette with Morgan Stanley. Your line is open.
Thanks. I will also keep my question to one mainly because Chuck said, please. Jayshree, I'm wondering if you can comment just on the general macro environment. We have a lot of conversations with investors about kind of what the demand picture, particularly from hyperscale looks like and, what the competitive environment is, if there's changes there from existing competition or from white box. So just like to hear kind of how you're viewing the both the demand and competitive sides of of the market, particularly for hyperscale customers.
Thank you, James. Is James the popular name today for questions? So, metro environment for cloud titans or cloud hyperscale in general is good and healthy they continue to be our number one vertical, both in Q1, Q2, and I anticipate that's going to be the same in second half. With the certifications, you know, the worst event behind us and much much of the cloud spend available. It's always competitive.
It's always dynamic, but I think Arista is strongly considered continues to be considered an important partner and vendor for the cloud titans. So I have not seen any appreciable change in the competitive landscape. I think we have strong spending that we can expect from them throughout this year. And the white box is a white box, meaning some of them have captive implementations in their own sites and have had it even before Arista was founded. And we continue to work with them in several tiers, but nothing new there as well.
Thank you, James.
Your next question comes from Samik Chatterjee with JP Morgan. Your line is open.
Hi, thanks for taking my question. I just wanted to ask on the acquisition. What do you can you share some details on module networks and the pipeline of customers that they're already working with and what is kind of your expectation in terms of revenue synergies from this transaction?
I'll give it my best shot. It's very early days. What fascinated us about Mojo is As you know, we believe the cognitive edge for the campus is changing significantly. And in the past, WIfi was always a second class citizen to wired. You never talked about performance of Wi Fi in gigabits.
It was always megabits of very small speed. And what we're seeing now at 802.1ax and performances in general is Wi Fi is approaching multi gig speed just like wired is. So the synergy for us is to really focus on making Mojo a software based acquisition where we care less about the access point and we care more about the cognitive controls, the integration into CloudVision and Kent's CMP architecture, And the importance of bringing all of these cognitive controls, not just to the spline, but to the Wi Fi edge. The company has been around a long time, they have a deep expertise in not only Wi Fi, but also on security with their wireless intrusion services. And Ken, if you're with us in the room and you spent a fair amount of time on the due diligence, maybe you want to add a few words to that.
What do you think the promise of Mojo is.
We just felt very good alignment with the Mojo team from a technical architecture point of view that the state management approach that we pioneered in EOS they've done something similar on the Wi Fi management side. And so we just felt like, it's going to be really exciting to make our products work together as a seamless group.
Your next question comes from Sami Badri with Credit Suisse.
My question has more to do with operating margins. And I know given the campus switching opportunity, you will be scaling the channel or giving we expect operating margin in the corporate level to converge down to where you guided to it at your Analyst Day more on the 32% to 34% range? Just want to get some perspective on that and the plan as far as sales and marketing spend given you just came in above 36%.
Yes. I mean, I think we'd still revert back to over the long term, we see the model as being the 32% to 34% And within that, we've talked about the different levels of investment with sales and marketing being in the 10% range. That doesn't happen overnight, right. I mean, we have to grow into it. So it is going to take time and obviously it depends on what the top line is doing at the same time.
But I think that's still kind of the longer term model. Is that it would be a 10% plus or minus sales and marketing investment. And we think with that, just given the different parts of the business, that can support an adequate investment from a sales and marketing perspective in the enterprise slash campus part of
the business. And you may recall, Eeta shared this at Analyst Day that in the sales and marketing, we expect the enterprise and international to be higher than the averages. We expect the cloud to be lower than the averages because it's a very technology driven, support and sales model. So Obviously, there'll be moving parts on different verticals there.
Got it. And then just one follow-up related to one of your peers. Noting that cloud deals got pushed out. Is Arista Networks seeing a very similar dynamic with key customers?
No.
Got it. Thank you.
Your next question comes from Simon Leopold with Raymond James. Your line is open.
Thank you for taking my question. On on the last call and at the Analyst Meeting, Andy had made some comments about, I I guess an inflection point in 100 gig. I'm wondering if we could get a little bit more color on your trends in terms of 100 gig ports, whether you're seeing some kind of inflection point, and whether this this helps your overall, ASPs grow and whether this is an element helping your overall cloud business.
Okay. Thanks, Simon. Well, I think it's safe to say Arista has really emerged in the last year as a market leader in 100 gig. When you look at all the ports we are driving and the associated ASPs, Most market analysts would have us at Mark Foster showing me some data anyway from 35 to 40 plus percent in market share. So we are the number 1 in 100 gig and have been for the entire 2017.
We haven't seen that change in 2018. I think the reasons for that are many and Andy is absolutely correct. 100 gig ends up being that common denominator of spine aggregation of spine aggregation that's just perfect for many use cases. It can be a value server aggregation. It can be storage.
It can be campus. It can be security. So we see that when I when I guess when you say inflection point, we see a continued inflection point for the next several years is probably the way I would say it. That it's just inflicting for quite a while here. And that as 400 gig comes in in 2019 2020, 100 gig continues to be vibrant.
So we see the 2 working in tandem in the later years, but currently, 100 gig is very, very strong.
And Are there
metrics you can share in terms per a percent of sales or percent of ports, something to to help us understand that?
So it depends on the vertical, but to give you a general sense, in the cloud vertical, 100 gig is extremely important. I can't think of a single cloud use case where we don't discuss, implement or, or, or, or deploy 100 gig, in the leaf or spine. In the enterprise, it can vary. 10 gig can be very important then and they may sometimes look at 40 gig, but they're certainly starting to see The earlier doctors of enterprise also embrace 100 gig, but that's where it can vary a little bit. The other big thing we're seeing is you can see quite an excitement in the cloud environment on modular 100 gig.
Which is stronger with particularly the large scale cloud operators, base lining on a large amount of ports. So the scale of 100 gig is far greater. And so, but at the same time, when you go into some of the Tier 1, Tier 2 service providers, we're seeing a lot of 100 gig in the data center or in the residential homes as well. So I guess the net of this is we see that a high performance 10, 25, 40, 100 gig is very much a risk that strong, strong suite with a much stronger position in 100 gig itself.
Thank you.
Your next question comes from Alex Henderson with Needham. Your line is open.
Great, thanks. I'm hoping, you will give us a little bit more granularity on the acquisitions contributions given the fact that it's going to close, according to the press release in the third quarter, what is included or not included in the guidance for it. And the other data point I was looking for was, the aggregate enterprise business, if you aggregate all of the various enterprise verticals, what was the growth rate in enterprise year over year in the quarter? Just reported.
Yes, I don't know that we're going to give the exact growth rate, Alex, quarter over quarter, but it was healthy, right? I mean, enterprise in the enterprise was in the kind of tide for the number 2 slot in our verticals and it continued to grow, to grow healthily. Right. I think the, when you think about the acquisition and incorporating it into the numbers, this is a software model. It's a ratable model.
So it's going to particularly as we work through some of the purchase accounting, etcetera. It's going to have not a very significant impact in the numbers in Q3. So I think for now, you can take the guidance as is, and expect it not to change just because of the acquisition. I mean going forward, obviously, it will be a contributor to, to our software ratable revenue stream. In the future.
But I think for Q3 and the guidance, you should just take the guidance open.
What about on the cost side of the equation for that? I assume that the costs are there.
I would I would be inclined to say something similar, right? We will have the costs there for, you know, it's effectively less than the quarter, right? It won't be there for the whole quarter. So it can it'll be easily absorbed into the guidance that we gave you already.
Your next question comes from Jason Ader with William Blair. Your line is open.
Thanks. Hi guys. For your campus strategy, how should we think about the wiring closet? The Mojo acquisition, obviously, shows that you've felt that you needed wireless to bolster bolster your campus offering. Should we expect to see wiring closet switches from Arista?
Ultimately?
I think we're approaching the campus, Jason, in a very steady systematic manner. Similar to the way we did the data center. So we're not married to the entire campus portfolio coming from Arista. HPE is a good partner for us. So our first approach will be the cognitive management plane and Slides.
Our phase 2 approach will be in wireless endpoints or edges that require that. And depending on how we do, we don't rule out the possibility of entering deeper in the market, but we are not we're not making any roadmap suggestions or announcements here.
Okay. And did Aruba, sorry, just quick one, how did Aruba respond to this?
We've had a 3, 4 year partnership, this is a very professional partnership and there's also a deep friendship. We're not doing this partnership is well beyond the Mojo acquisition. We're working very closely in the data center and we continue we will continue to work together in the campus as well. So they understand our strategy and we understand their and we work together. And 90% of it is complimentary.
Your next question comes from Aaron Rakers with Wells Fargo. Your line is open.
Yeah, thank you for taking the question. One of the things I didn't hear a lot of on this call at this point has been your router business. I'm just curious if you have any update as it relates to the traction in the router market. And then in particular, how should we think about the next phase, if you will, of expansion of opportunities in that router market. Is that tied to things like Jericho 2 silicon or is there other things that we could look at over the next 12 months or so to say that, Hey, Arista is expanding further.
Yes, no, thanks, Aaron. Should have said a little bit more. We are very proud of our focus on routing. As you know, we don't need to wait for Jericho too. Arista is also already making great inroads with the flex route licenses we have.
And it has grown steadily quarter over quarter. You might know that we ended, ended the year last year reporting that we were over 200 FlexRoute licenses and rather than reporting it quarter over quarter since it's no more new, I told you guys, I'll come back to you at the end of the year. I fully expect we will double that. And I fully expect we will continue to see new customers like we do every quarter. The customers come in a variety of categories.
They come in terms of new use cases in the cloud. To new enterprises to, of course, Tier 1 and Tier 2 service provider. If there's an area, I would challenge myself and the team to do better. It's probably the service provider. If they take a little longer and it certainly tested, Arista's patients, I think technologically, we're doing very, very well with them.
But operationally it takes longer to test and deploy.
Your next question comes from James Suva with Citi. Your line is open.
Thank you so much for the details thus far. Just one question for me. And if I heard the prepared comments correctly, it was kind of no change to 2018 outlook. But I'm just trying to bridge the different pieces here. Have you just beat in a very impressive way, you know, organically, you barely beat me and you added on an acquisition that's going to close in Q3, but you mentioned no change really to Q3 or 2018.
So are you seeing some softness in your order book going forward? I mean, your deferred revenues came down some when you're saying more change. You have an acquisition plus it just be. So I'm just trying to put those all pieces together. Thank you so much.
Yes. I think, Jim, if you look at what we did, we grew 28% in Q2. We guided 26% at the upper end of the range. Right, and then we'll see what we do from there. You know, the acquisition, like I said, it is a software model.
So it'll be a it'll be a ratable rev rec model. So we need to work through some of that, but it's not likely to be a big driver, of top line just because we'll have to do some of the purchase accounting on their deferred and then will be a ratable model from thereon, right? But I think, you know, we're looking at we're saying we're still consistent to our mid-20s for the back half of the year, you know, the up end of the guidance the up end of the range is a 26% growth rate and then we'll see what we do from there. But I don't think we've seen any particular softness in the business. You would have heard my comments on deferred revenue.
I think the deferred revenue stabilized now. So the Q3 guide is, should not benefit from deferred or from a decline in product deferred should stand on its own. So I think we're pretty happy with that as a guidance case and then we'll go from there.
Great. Thank you so much for your details. Much appreciated.
Thanks James.
Your next question comes from Alex Kurtz with KeyBanc. Your line is open.
Hi, this is Steve Enders on for Alex. Thanks for taking my question. I was wondering if you could characterize the trends you're seeing in cloud tightened spend at this point? Is it more coming from new data center build outs or is it more about expansion of existing footprint?
Steve, it's always a combination of both. As you know, majority of our cloud titan customers are not just incrementally growing. They're always constructing new data centers, but they also have to go back in their existing data centers and incrementally add. So we're seeing a nice combination of both. So I wouldn't put weightage on one versus the other.
Both sides are doing well.
Has there been any change in the mix there over the past year?
Well, I think because of the 100 gig onset, the biggest change to the mix is, is it more 100 gig in both examples. Beyond that, no big change.
Your next question comes from Paul Silverstein with Cowen. Your line is open.
I'm sure you're going to love me after these questions. First off, I apologize. I'm a little
Just one question, Paul, right?
Well, I I I'm a little slow in the uptake, so I'm I'm hoping you'll just clarify some things for me. On Simon's question about Mojo revenue and the 3rd quarter guidance, you're saying that guidance does include or does not include any revenue for Mojo?
Yes, I mean, it's, it's, it's going to get incorporated sometime mid Q3 and it's a ratable software model. So It's not going to move the needle is what we're really saying.
All right. We're saying it's a small acquisition and the revenue is small. So whether it does or doesn't is well within the error of our guidance.
All right. And on the calendar 2018 revenue guidance, you're saying you're expecting mid-20s for the back half of the year as opposed to mid-20s for the whole year?
Correct.
All right. And now for the real questions. Pricing, any change one way or the other?
Paul, I've said this before, no dramatic change. Same aggressive competitive situation we've always seen. So No different than last quarter.
All right. Now that I've got those clarifications out of the way. I appreciate that. My final question. With respect to Well, let's hold it for the for a callback, please.
No worries.
Your next question comes from Mitch Steves with RBC Capital Markets. Your line is open.
Hey guys, thanks for taking my question. I just had one actually, so I have fortunate ability to Google the CEO's name. So it says that Mojo Networks is supposed to get to on $100,000,000 run rate in about 2 years and this article is dated as of January of 2018. So my question is, is there any reason why you wouldn't be able to exceed that? Expectation due to being integrated with Arista, I.
E, is there any sales synergies with the Moja Networks and Arista work in the other?
Oh, boy, that sounds like an ambitious goal from their current revenue. So I'll have I'll have to speak to Rick about my forecasting talents versus his. But how about we come back to you on that one after we know better on integration? That sounds like a very high number.
Okay. Got it.
Thanks Mitch. I owe you an answer.
Your next question comes from Rod Hall with Goldman Sachs. Your line is open.
Yeah, hi, thanks for the question. I wanted to I just wanted to come back to we've had a lot of incoming questions from investors about inventories at your large, cloud titan customers? And maybe there's a theory, I guess, floating around that maybe they have some inventory a result of the patent cases that they're unwinding and that's having an effect on sales maybe in the short term. So I wonder if you could comment on that and also the fact that even at the 25% growth rate in the second half, your seasonality has shifted pretty significantly. Toward the first half of the year more so than normal.
Normally, we see bit more revenue in the back end of the year. So I'm just curious if you could maybe weave those two things together for me?
Yes. I mean, I think just the revenue trend, let's just take that first. I mean, obviously, Q1, we grew 40 plus percent year over year because that was much easier comp, off of the first quarter last year, right? So I don't think there's anything that's fairly different in seasonality that we're calling out, at least it's point. So again, we're saying mid-20s for the back half of the year.
And like I said, it's 26% at the upper end of the range for Q3 and, and we'll see where we go from there.
So so just to iterate what, Edith said, Rod, we're feeling very good about cloud spending. We have in Q1. We definitely do in the Q2 results and the second half is looking strong. So when you say they have some inventory, I mean, there's always there's always this issue of did they order the right mix, but we don't see that as a category
I'm not saying they have inventory. I'm just I'm really asking you if you think they have inventory.
Yes. Okay. All right. So I would say Rob, that speculation is probably not what we're seeing. We're seeing healthy demand.
And if they had an inventory, they probably wouldn't be buying more. Right. So from our perspective, the cloud, which was kind of in a hiccup for us when you're going through certifications and last Q3, Q4 is back and it's back strongly.
Your next question comes from Jeff Kvaal with Nomura Instinet. Your line is open.
Thank you all very much last year, the 100 gig transition obviously was very, very favorable for you all. We've got another one another tech transition happening in about a year with 400, or certainly in 2019. Can you talk about your positioning for 400 and maybe perhaps your relative positioning versus the competition with $100,000,000, it was you were so far out in front that you gained a lot of share. Should we think that that your competitive lead there has stayed the same and so there's more share to take or is this more of a today's share gain situation? Thanks.
Thank you, Jeff. If you would ask me to predict whether we would have a Sedate share gain in 100 gig, I would have thought perhaps that would be the case. So we were pleasantly surprised to see the dramatic market share gains in 100 gig. And I would attribute that to 2 reasons. 1, Ken and the team building excellent products.
And the other, our competition did not, you know, respond to 100 gig as well as we did. So now let's switch gears to your 400 gig question my view, as I said, quite often, is the 100 gig inflection is a multi year inflection. We're going to continue to see strength And this is going to be, you know, in the form of higher density, in the form of additional options and form factors in, in the form of, 200 gig options. So I don't think the onset of 400 gig in any way changes the momentum on 100 gig. This is really important to remember and know, because this is going to be the largest market.
Now as the market lead and 100 gig naturally Arista works with its customers and instead of hyping and making any pre announcements, we are making sure architecture is 400 gig capable. And we absolutely will support that and you will expect to see trials and product capabilities from us We're usually first to market. I don't see why we wouldn't be this time.
Okay. And when might first to market be? Is that a first half twenty nineteen or a little earlier perhaps.
When I introduce it, you will hear about it.
All right. All right, Jayshree.
Thank you.
And you know why I say that? A lot of this is dependent on the chip vendors. And making sure we get a real production worthy product and we're not just putting out samples that we can ramp nicely because it's not how we put Unit 1 that matters. It's how we put Unit 1000 that also matters. With the right quality as Ken will remind me.
Thank you, Jeff.
Your next question comes from Srini Pajjuri with Macquarie Securities. Your line is open.
Thank you. I have a question on margins, Zeta. So, I thought the cloud titan strength is somewhat negative to gross margins. I was somewhat surprised by the gross margin strength. And along the same lines, I'm trying to understand what's driving the operating margin guidance, almost a 400 basis points of decline.
Is it simply higher spending or anything else going on there? Thank you.
Yes. No, so you're correct that in a quarter where we have a heavier cloud mix, you should expect that to pressure gross margin, right, still within our 63 to 65 range. And we had guided for that, right. You know, we did test the team to focus on gross margin and focus on cost control, etcetera, this quarter to help offset that. And they did a pretty nice job of that.
And obviously, the higher service content contribute a little bit to that too, right? But as a general statement, I would stand by the 63 to 65 with cloud pressuring is, to the lower end, depending on where we are in a quarter. I think that's the way to think about it. The operating margin guide for the for the quarter is really the long term model, right, which is a 32% to 34%. We'll grow into that over time, right?
It's not going to happen straight away, but that's when you look at the investment thesis we laid out, that's where we think we will be in the longer term.
And they're going to absorb a fair amount of employees with the acquisition, right?
So we
will have more expense.
Okay. So you're including the OpEx from the acquisition in the outlook, but not the revenue?
Yes, we're definitely including some expense there. But again, I would think about the $32,000,000 to $34,000,000 as a longer term model that we're growing into. So it won't happen overnight. Okay.
Got it. Thank you.
The expense is guaranteed. The revenue is not.
Okay. Makes sense. Thank you.
Your next question comes from Vijay Bhagavath with Deutsche Bank. Your line is open.
Hi. Thanks. Yeah. Hey. Hi, Jayshree.
Are you there?
Hi. I'm James. Yeah.
I I'm not James, fortunately. So, you know, Jayshree, a big a bigger picture question, you know, the campus honestly has been a channel sale. So I'd like to get to your your viewpoint, Jayshree. How do you plan to kind of build and scale A channel and also your direct sales footprint. Now that you have, you know, a wireless asset to sell, you have campus course switching.
Thank you.
Thank you, Vijay. Yeah, that is a good question and one we won't get to overnight. As you were at the Analyst Day, you probably observed our first natural synergy in the campus will be our own customers who already know us and love us for EUS. Our second will be as we build out our enterprise sales force, we fully expect that that'll be direct customer driven and channel driven. And the 3rd order would probably be especially a focus internationally where we already have channel presence.
So this is something Manny Rivello and Anshul are working very closely on, but it's a work in progress and we'll take time.
Okay. Thank you.
Thank you, Vijay.
Your next question comes from Erik Suppiger with JMP Securities. Your line is open.
Eric, are you there? I think we lost Eric. Sorry. We missed the first part. Yeah.
Can you hear me alright?
We can now.
You can hear me okay? Yes.
We can hear you now. We can need to restart.
Sorry about that. Alright. I just wanted to understand, you had noted that, the long term guidance is 32% to 34%. But you're guiding for Q3 to be 32% to 34%. Is that to suggest that there's upside to that in the near term?
Is that how we should be thinking about your Q3 guidance?
No, I mean, I think that's the guide. And obviously, we will have to absorb some costs from the acquisition, etcetera, on top of that. So, you know, we're reserving the right to spend what we need to spend to do that. So I think that's the guide, but I think we've talked about this in the past, but we will go into those investments.
We're going to continue to aggressively invest in R&D. And as you all keep asking me, we also need to invest in the sales and marketing and enterprise channels. So on one hand, you expect us to do that. On the other hand, you say, gee, why isn't it higher? So if we don't execute, we'd be higher, but we want to execute.
Can you tell us how many people is Mojo Networks?
Yeah. It's over 250 employees.
Okay. And then real quick, the Mojo solution is software. That's the only product in your portfolio that's just a software based solution. Might we assume that your campus, this might lead you to more campus products that'll be white box and your portion will be just the software aspect of it that reflective of a longer term strategy?
We'll take this question offline, but I'll give you a short answer to it. First of all, the Mojo product is not our first software product. We have 4 or 5 already in flight, cloud vision, our macro segmentation security, our FlexRoute licenses, CAP aggregation dance products. So we have a number of software only options, and CloudVision is probably the best example of that. And, I think the way to look at this is, software has to run on something.
It does run on hardware. And at any given time, you look for technology, no matter which way it's packaged, software only, software plus hardware or in the case of a lot of optics and cables, it's hardware only. So we haven't really formed a strategy of software only, but we do the right thing, which makes sense. And in this case, it was such a natural synergy with the cognitive campus vision we have and the cloud managed products we have with cloud vision that, this is a very nice software based acquisition.
Very good. Thank you.
Thank you, Eric.
Your next question comes from George Notter with Jefferies. Your line is open.
Hi, guys. Thanks very much. So I'm looking at the Mojo website right now. It says here they make access points and, wiring closet switches. And so I guess I understand or I'm trying to understand the cognitive wifi pioneer, but Are you saying then you're going to discontinue those kinds of hardware based products?
Or I assume more likely you'll continue to sell those in the marketplace. And then more broadly, I guess I'm just trying to understand kind of what the bigger picture is here for Arista. I mean, when you guys talked about, pushing into campus, you really focused on the notion that you were going to be focused on the core, where you had some natural synergies with your data center switch business. And, now it seems like you're going more broadly into the campus. And I guess I just want to understand kind of where you guys see the lines in terms of how you're going to compete in campus longer term?
Thanks.
Sure. Thanks, George. That's a loaded long question and I'll try to be concise. So there's no question that our primary strategy, as Ken alluded to, is the combination of our cognitive management plan and our Spline. We're leading with that.
That's our strength. It's a national extension from the data center. That's where we expect to succeed first. And then there's a diverse suite of edges. Majority of the edges will probably come from 3rd party partners or even competitors.
So we're not making any declaration of statement on modules PoE switches or on our PoE switches. There's no stated intent at this time here. What we bought Mojo for was their Wi Fi, their cognitive Wi Fi and the software capabilities associated with the access points. So give us a chance to integrate the acquisition and decide what we do and don't do and how we do it, but understand that the epicenter of Mojo is not the switches. It's really the Wi Fi.
Your last question comes from Hendi Susanto with Gabelli And Company. Your line is open.
Good evening and thank you for my questions. Jayshree, in the last Q1 call, there's a concern that demand for 100 kicks may normalize. 2018 after strong sales upside in 2017. I believe that was the main rationale of growth expectation in the mid-twenty percent Today, you sounded very optimistic about 100 gigs and its long tail inflection point. My question is should we still be watchful that at some point we may see 100 gigs to normalize?
So I don't think the first, so yeah, let me take this question in 2 halves, Sandy. Is 100 gig normalizing? No. We're still seeing a lot of demand and it's continuing to grow both from a total available market there's I don't see much normalization. It's got multi year growth and a risk disposition, right?
Now obviously 2017 was a real escalation year because we were literally going from nothing to everything. So the next few years, the rate of growth may be slower, but the dollars will be very large and very healthy and very rich for Vista. So that's one. So then the second thing is come back to the rate of growth again. The rate of growth has to do with the fact that we had 2, it's extremely exceptional quarters last year.
And that is more normalized to the mid-20s. If you look more broadly, off some very large base of numbers. We're now talking about north of $500,000,000 a quarter. So that should be confused with the fact that we can do well and we'll continue to do well in 100 gig.
Got it. That's very helpful. Thank you, Jayshree.
Thank you, Hendi.
This concludes the Arista Q2 2018 earnings call. Thank 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 additional 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