Welcome to the first quarter 2018 Arista Networks financial results earnings conference call. During the call, all participants will be in a listen-only mode. After the presentation, we will conduct a question and answer session. Instructions will be provided at that time. If at any time during the conference you need to reach an operator, please press star followed by zero. 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. Charles Yager, Director of Investor Relations. Sir, you may begin.
Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me on today's call are Jayshree Ullal, Arista Networks President and Chief Executive Officer, and Ita Brennan, Arista's Chief Financial Officer. This afternoon, Arista Networks issued a press release announcing the release of its fiscal first quarter 2018. If you'd 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 for the second quarter of the 2018 fiscal year, industry innovations, our market opportunity, and the impact of litigation, which 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 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, and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. Please note that certain financial measures we use on this call are expressed on a non-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, Charles. Thank you everyone for joining us this afternoon for our first quarter of 2018 earnings call. I am pleased to report that we had a good quarter given the normal seasonality. We demonstrated our predictable profitable growth with non-GAAP revenue of $472.5 million as we grew more than 40% year-over-year. Non-GAAP earnings per share was $1.66, with services contributing 13.7% of overall sales. From a geographic perspective, our customers in the Americas contributed 67% of the total revenue, while the rest of the international theaters progressed steadily in the quarter. We delivered non-GAAP gross margins of 64.4% in our highly dynamic and competitive industry. Our top ten customers included four out of the five verticals.
Cloud titans contributed strongly in Q1 and ranked as our number 1 vertical, followed by enterprises at number 2, service providers and cloud specialized providers pretty much tied at number 3, followed by financials. Our new customer acquisition continues to be healthy as we exceeded 5,000 cumulative customers this quarter, and we continue to perform well with FlexRoute, our routing license, and CloudVision software customers as well. At Arista, we have always embraced open networking trends by designing our platforms with merchant silicon diversity while using modern software to form differentiated cloud networks. On March 29th, Arista introduced the latest data center fixed leaf models based on Broadcom's Trident 3 and Tomahawk 2 silicon. Arista's 7050X3 and 7260X3 platforms run on the single EOS software image and CloudVision for operational consistency.
Some of the key innovations include intelligent buffering and automated network load balancing, packet and latency monitoring, new protocols such as Segment Routing and a fully featured VXLAN stack, high availability with hitless software upgrades, low power 25 gig and 100 gig fixed systems that are double the capacity of the predecessors, and cloud scale performance with 12.8 terabit scale and 4.2 billion packets per second of packet forwarding. On Open Compute Project's event in March 2018 in San Jose, Arista demonstrated disaggregated EOS via collaboration with two key cloud partners: Facebook with Wedge 100 and Microsoft with SONiC. As many of you may know, we began our Microsoft journey back in 2015 or 2016 with SAI, Switch Abstraction Interface, via code contributions to this initiative.
This year, Arista and Microsoft expanded the SONiC initiative across the flagship Arista 7500 as the only modular chassis supporting Microsoft management stack. Arista also supports EOS and Containerized EOS on Facebook's open Wedge 100. This allows customization of script for automating network operation flows. In both these cases, Arista's advanced EOS SDK is demonstrated in full action. This quarter, we also participated in routing interoperability at the MPLS + SDN + NFV World Congress event in Paris. We're gratified to be recognized for the first time in the Forrester Wave for hardware platforms in SDN as a leader with a top score in both strategy and current offerings in Q1 2018. We're also proud to be recognized as one of the top 10 employers in the Bay Area's best places to work in the large employee category, ranked number 9 out of 130 eligible companies.
As I look at Q1 2018 and reflect on our start, I am pleased with our performance and the trajectory ahead. In particular, we are now well beyond the overhead and delays of customer certifications that we had been experiencing during the past three quarters, having successfully completed most of the certifications. In light of the recent ITC suspensions on the remedial orders of the '668 patent, as well as the expiration of the '577 patent on June 30th, we pretty much expect to return to normalcy in the second half of 2018 with respect to 9.4.5. With that, I'd like to turn it over to Ita, our Chief Financial Officer, for Q1 2018 financial details. Ita?
Thanks, Jayshree, and good afternoon. This analysis of our Q1 results and our guidance for Q2 2018 is based on non-GAAP and excludes all non-cash stock-based compensation impacts 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 Q1 were $472.5 million, up 41% year-over-year and above our guidance of $450 million-$468 million. We were pleased with overall demand in the quarter, with particular strength from our Cloud Titan vertical. Service revenues represented approximately 13.7% of revenue, up slightly from prior quarters. International revenues for the quarter came in at $157 million, or 33% of total revenue, consistent with the prior period.
While some of this continued strength in international mix was related to deployments by our U.S. Cloud Titan customers, we also experienced healthy growth from our in-region international businesses in the period. Overall gross margin in Q1 was 64.4%, down from 65.9% last quarter, but above the midpoint of our guidance of 63%-65%. This reflected an anticipated return to a more typical customer mix for the first quarter. Operating expenses for the quarter were $137.4 million, down from $139.3 million last quarter. R&D spending came in at $91.4 million, or 19.3% of revenue, down from $96 million last quarter, with reduced NRE and prototype spending offset by headcount additions. Sales and marketing expense was $36.2 million, or 7.7% of revenue, up from $33.5 million last quarter, reflecting growth in headcount. Our operating income for the quarter was $166.7 million, or 35.3% of revenue.
Other income and expense for the quarter was a favorable $4.2 million, and our effective tax rate was 21.5%. The higher than anticipated tax rate reflects updated guidance in relation to the recently adopted Tax Act. This resulted in net income for the quarter of $134.1 million, or 28.4%. Our diluted share number for the quarter was 80.7 million shares, resulting in a diluted earnings per share number of $1.66, up 79% from the prior year. Legal expenses associated with the ongoing lawsuits came in at $7.1 million for the quarter, and are excluded from our non-GAAP results. Turning to the balance sheet. Cash, cash equivalents, and investments ended the quarter at approximately $1.7 billion. We generated $195.5 million of cash from operations in the March quarter. This reflects strong net income performance combined with overall improvements in working capital requirements.
DSOs came in at 39 days, down from 49 days in Q4, reflecting the timing of billings and collections in the quarter. Inventory turns were 2.2 times, up from 1.8 in Q4. Inventory decreased to $268.1 million in the quarter, down from $306.2 million in the prior period. This reflects reductions in both raw materials and finished goods as we continue to optimize our supply chain. In addition, we maintained a further $24 million of inventory deposits recorded in other assets, compared to $34 million last quarter. Our total deferred revenue balance was $456.1 million, down from $515.3 million in Q4. Product deferred revenue declined by approximately $50 million in the quarter, with customers completing many of their 9.4.5-related qualifications. In addition, as part of our adoption of ASC 606, we reclassified approximately $19 million of software-related deferred revenue to other contract liabilities on the balance sheet.
As we go forward, you should expect lower levels of product deferred revenue, given the relative maturity of the R-Series platform, completion of any remaining 9.4.5-related certifications, and the adoption of ASC 606. As a reminder, any such decline in deferred product revenue is not in and of itself an indication of a change in the underlying demand trends of the business. Accounts payable days were 38 days, up from 30 days in Q4, reflecting the timing of inventory receipts and payments. Capital expenditures for the quarter were $6.3 million. Now turning to our outlook for the second quarter and beyond. We are pleased with the momentum of the business in the first quarter, with strong demand, particularly from our cloud customers. 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.
Given some tough 2017 comparables, we believe that the current consensus for the balance of the year, which calls for year-over-year growth in the mid-20% range, remains relevant. Our gross margin guidance for the second quarter of 62%-64% reflects an anticipated mix towards cloud revenues in the quarter. We now expect our go-forward non-GAAP tax rate to be in the range of 21%-22%, reflecting further guidance on elements of the recently adopted Tax Act. With this as a backdrop, our guidance for the second quarter, which is based on non-GAAP results and excludes any non-cash stock-based compensation impacts and any legal costs associated with the ongoing lawsuits, is as follows. Revenues of approximately $500 million-$514 million, gross margin of approximately 62%-64%, operating margin of approximately 32%-34%.
Our effective tax rate is expected to be approximately 21.5%, with diluted shares of approximately 81 million. Please note that based on our current outlook, we expect costs associated with the ongoing lawsuits to be approximately $6 million for the quarter. I will now turn the call back to Charles. Charles?
Thank you, Ita. We are now going to move to the Q&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 the Q&A portion of the Arista earnings call. In order to ask a question during this time, simply press star then the number one on your telephone keypad. If you'd like to withdraw your question, press the pound key. We ask that you pick up your handset if we're asking questions in order to ensure optimal sound quality. Your first question comes from Rod Hall with Goldman Sachs. Your line is open.
Yeah. Hi, guys. Thanks for taking the question. I guess I wanted to focus on the 945 certifications and just ask a couple of questions around that. Number 1, is all the deferred revenue associated with those now released, or is there still some deferred revenue balance associated with those certifications? I wanted to be clear on that. My bigger question is, you guys had called out some project-oriented delays as a result of those certifications. Are those projects back online now, or are you still ramping back to normal spending with some of those customers that were waiting to certify? Thanks.
Thanks, Rod. I'll take the second one first and then hand off to Ita on the deferred piece. I think we, having now completed majority of our certifications, and if you recall, I was explaining how some of the complex use cases took time. We feel pretty good about that. In 2018, we're pretty much now starting to look at the impact of certifications to be very minimal in Q2 and virtually non-existent in the second half. We're ramping back to new projects now, so the worst is behind us. Ita?
Just to take your first question, Rod, I think there is still some 945 certification-related deferred there. It's small. There's some other unrelated stuff, just normal kind of feature delivery type deferred that's in the balance sheet. That number is now going to be much smaller, and it'll rotate just based on features and value of features as we make commitments in particular contracts going forward.
I wonder, just to follow up, could you guys comment a little bit on what you're seeing with respect to AI workloads and spending there, and do you think you have the majority of the networking in that market, or do you find that there's quite a bit of competition around? Just curious how that's going.
Well, I think the whole AI space is very exciting. It's clearly in very early stages. In fact, just two weeks ago, we were on a roadshow with our partners, NVIDIA and our storage partner, Pure. What I would say to that is clearly the importance of AI is to reduce cycle time, and that has a profound impact on the bandwidth, performance, capacity, and latency of networking. We derive an indirect benefit as a result of the large amounts of GPU. Still very early stages, I would say, in experimental stages.
Great. Okay. Thank you.
Thanks, Rod.
Your next question comes from James Suva with Citi. Your line is open.
Thanks very much. Given a lot of the news about privacy concerns and geopolitical trade wars and tensions, such like that, have you seen any change in behavior to your cloud spending or any of your customers, either in a positive or pausing manner? What I'm getting at is, are they looking at putting in some more of your product because of these concerns or some less, or waiting to figure it out, and especially with the trade wars?
Oh, wow. Thanks, James. That's a heavy-duty question. I'm going to start to answer it, but I won't do enough justice. Anshul Sadana, our Chief Customer Officer, who's much more intimate with the cloud, will give you more details. When we look at the whole security and privacy space, I think there's an element of how we work closely with our security vendors, an element of isolation and segmentation, and a strong element of audit compliance and encryption. Particularly since the cloud vendors are deploying a lot of data centers, the encryption and the ownership of the fiber becomes a big deal. Anshul, you want to say some more?
Absolutely, Jayshree. The data protection in the cloud is very relevant, not so much with respect to the trade wars, but with things like GDPR or any local laws that exist. When you look at the cloud companies and the regions they are building out, you'll see that some of the regions are smaller and localized within Western Europe or one-off countries. That's all the impact that we see. That's all part of the cloud business that we're already in.
Great. Thank you so much for the details. It's appreciated. Thank you.
Thank you, James.
Your next question comes from Srini Pajjuri from Macquarie. Your line is open.
Quick questions, Ita. You mentioned mid-20% growth is where you're comfortable for the year. Obviously, you grew 40% in Q1. Does this mean your second half, you're assuming some sort of deceleration from the mid-20%, or do you expect that to be within that ballpark? Just one clarification. You said ASC 606 had, like, $19 million impact on deferred revenues. Did that help you in terms of revenue in the quarter? Thank you.
On the first one, I think the commentary was that for the balance of the year, so for the remainder of the year, we would say we think the mid-20s is a reasonable way to think about the growth rate, right? Not incorporating the Q1 growth rate. On the ASC 606, it's really a balance sheet reclass. It's kind of on a technicality where we have some prepaid subscriptions, and we're required to record it as a Contract liability as opposed to deferred revenue. It's really just a relocation on the balance sheet from deferred to other contract liabilities, but not flowing through the P&L.
Great. Thank you.
Your next question comes from Jeff Kvaal with Nomura. Your line is open.
Thanks very much. We've been hit by a raft of headlines from the cloud spenders over the last week or so, talking about big beats in their CapEx. It sounds like that is pretty closely tied to what is going on in their underlying business. CapEx for them ought to be growing faster in 2018 than it grew in 2017. It looks like you all are set to grow a little slower in 2018 versus last year. Can you help us bridge that gap? I understand from quarter to quarter things fluctuate, but over the course of the year, we would like to think that things would balance out a little bit. Thank you.
Most certainly, Jeff. As you know, cloud titans do have seasonal spending, and we have enjoyed a very strong partnership with many of them and continue to. Our heritage is undoubtedly, and our forecasts and our past, our present, and our future is very much tied to cloud networking for all types of customers. I think what you should take away from this is, while we have a great deal of visibility to the near future, which is one or two quarters, their spending for the entire year or subsequent quarters involves a lot of moves and shifts, and networking is still a very small piece of their CapEx. We continue to understand those use cases. Anshul and the team are very intimately involved, and we have no reason to believe that we aren't technically or business-wise in strong partnerships.
We will only know more, say, for Q4, around Q2 or Q3. Therefore, it's really hard to predict, and we try not to since sometimes they don't know, and therefore we don't know either. Anshul, you want to add anything more to that?
Absolutely. I want to remind everyone, we've discussed this in the past, that for the cloud companies, a data center build-out or a regional build-out is a two-to-three-year project. When the networking components land and we see the product bookings and revenue, it's not exactly in the same month or the same quarter. The lag could be as much as 18 months for the bigger regions. That's why it's very hard for us to forecast this.
Yeah, I will remind you, Jeff, that cloud was strong from a momentum, from a demand perspective in Q1. I think it's typically strong, and we saw that again this quarter.
Okay. Thank you. Then maybe to probe on that a little bit, you talked about.
I'm sorry, we're just going to limit it, Jeff, to one question, if you don't mind.
Oh, you got me, Charles. You got me. Go ahead.
Thanks, Jeff.
Your next question comes from Alex Kurtz with KeyBanc. Your line is open.
Hi, guys. This is Steven Enders on for Alex. I was wondering if you guys had seen any change in mix of top-of-rack switches and spine within your hyperscale customers over the past few years, or how that's trended, and how does that also compare in the service provider segment?
We don't see any appreciable change. The spine and routing has given us more use cases in the cloud and service provider, but leaf gives us a lot of ports, so overall, not much difference.
Thank you.
Steve. Thank you, Steve.
Your next question comes from Paul Silverstein with Cowen & Company. Your line is open.
I'll keep it simple. A clarification question.
Paul, you're sounding very muffled.
Yeah, we can't hear you, Paul.
Paul [uncertain]
Can't hear you.
Can you skip him and then we'll come back?
Yeah, can we come back to you, Paul? We need better quality.
Can't hear you. You're very muffled. Let's fix that line, and we'll come back to you.
Your next question comes from Ittai Kidron with Oppenheimer. Your line is open.
Thanks. Good quarter out of the gate, guys. I guess ladies and guy. Help me think about when you talk about the mid-20s for the remainder of the year, including the second quarter, can you help me think, if I look at that on a vertical standpoint, which verticals you think can outperform that bar versus underperform that bar?
I don't think we're going to try to do that. Obviously there are a number of various different scenarios as we move through the year where we'll see strong demand in some cases and others. We set our guidance based on a number of different potential outcomes, but I'm not going to go and try and lay out a single case here.
Thanks, Ittai. We'll try to do our best going forward, as you know, some of these verticals are very lumpy. For example, we may do really well in one quarter with service provider or really well in enterprise if we win a large number of enterprise customers. In general, all of them are doing well and contributing double digits in terms of segments. We hope they all have the possibility of growing well north of 40%.
Got it. Can you give a little bit of an update on how enterprise is going for you, as that's important going forward?
I think clearly it was our number 2 vertical in Q1, we tend to pull out enterprise from financials. If you added the financials, it would've been pretty close to our number 1 vertical. I would say we continue to do very well in the enterprise. Customers are incredibly frustrated and seeking an alternative, both for quality and innovation reasons. The size of enterprise opportunities always start small, there is a long testing period, we're pleased with our performance. Our customer gain in Q1 was very strong, just like it was in Q3 and Q4 last year.
Very good. Good luck.
Thank you, Ittai.
Your next question comes from Mark Moskowitz with Barclays. Your line is open.
Thank you. Good afternoon. Just wanted to see if you could touch on where we are in the 100G cycle. It seems to be a question we get a lot from investors in terms of Arista's prime mover or first-mover advantage there. Are we in the third inning, the fourth inning? Sorry to use a baseball analogy, but how should investors think about Arista's momentum there with respect to 100G?
Well, if you use the cricket analogy, we're not even in the first inning. If you use the baseball analogy, I would say we're still between the first and second innings. I think 100G is going to prove to be a very strong requirement, not only because we were the first mover last year, but we'll continue to be the first mover for many forms and flavors of it. It's important to understand it's not one product. It's going to permeate the entire cloud networking, and as we start to move more 25 gig and 50 gig into the downlinks with storage and compute, the need for 100G moves into the spine, into the data center interconnect, into the routing flavors. We continue to believe that we will have large share and build upon our first-mover advantage.
We also believe that the arrival of 400G next year will only make us stronger in 100G. The two will go in tandem.
Thank you.
Thanks, Mark.
Your next question comes from Aaron Rakers with Wells Fargo. Your line is open.
Yeah, thanks for taking the question. I just want to go on the gross margin line and understand, I think this quarter, looking at the guidance of 62%-64%, that would compare to 63%-65% guidance ranges over the last couple of quarters. Just curious of what's changing there, if there's anything within the mix or assumptions there that resulted a little bit of a lower gross margin assumption.
Yeah, I think the biggest driver still for our gross margin is within that 63-65 range is going to be customer mix. As we head into Q2, we believe we will have a heavier cloud, so large customer-based mix in Q2. That's causing us to be a little more cautious around the gross margin guide and the gross margin outlook. It's really a customer mix question. I think the 63-65 for the year, we still feel good about.
Okay. Thank you.
Thank you.
Your next question comes from Hendi Susanto with Gabelli. Your line is open.
Good evening, and thank you for taking my questions. Congrats on seeing strong sales in Q1 and then enterprise sales. I have heard market commentaries that despite of strengths in Arista's enterprise sales, Arista is still having low penetration among enterprises. Jayshree, would you be able to share insight into opportunities, outlook, and the current state of enterprise penetration for both routing and switching?
Okay. Thanks, Hendi. I would have to agree with you that Arista can improve its penetration in the enterprise. It's a huge opportunity for us, and even though we're doing well, we could do even better. Our penetration is both in switching and routing, we're not seeing low penetration in either. I think our penetration in switching is stronger than routing, because routing, especially for the scale of capability we offer, tends to be favored by the larger service providers and cloud providers. I would say in general, I would like to see Arista do better, but we're doing very well.
Thank you.
Thank you, Hendi.
Your next question comes from Mitch Steves with RBC Capital Markets. Your line is open.
Hey, guys. Thanks for taking my questions. Just on the gross margin guidance, I want to get back to that a little bit. Given that the cloud vertical is supposed to be the fastest-growing and largest piece, wouldn't we expect the margins to actually increase given that the hyperscale guys typically buy the higher-end products? Or I guess, what am I missing there in terms of the mix dynamic?
If you look historically, the mix factor has tended to be, if we have a lot of cloud or large customers, then obviously they have better, more competitive pricing, and that tends to drive a lower gross margin.
Just to clarify what Ita said, I couldn't agree more, Mitch. Our cloud gross margins are driven by volume, volumes drive lower prices and therefore lower gross margins to us. Our cloud titan margin is significantly below the corporate average.
Right.
Your next question comes from James Faucette with Morgan Stanley. Your line is open.
Thank you very much. I want to just ask about efforts to continue to expand the customer base both domestically and internationally, the progress you're making there. One of the things that we've been seeing is that there continue to be what seem to be, at least to us, somewhat extended lead times on delivery, I'd like to hear how you're thinking about that, what the progress has been, and how we should think about opportunities going forward. Thanks.
Thanks, James. You may remember I said we hired Manny Rivelo, and the specific goal here especially was to help with international expansion and enterprise. I think we're both investing very well in that and expanding in certain verticals. The M&E vertical is a particularly strong one for us. We just came out of a strong network broadcasting show. I think we can do even more in the international theaters. As you can see, our ratios and percentages have changed by 5-10 points in the last few quarters, but we can do even more. There's no denying that, similar to the last answer I gave, that Arista's opportunity and execution in enterprise can be even stronger. As you also know, enterprises are risk-averse, and only in the last year, I would say, they have started to take Arista seriously.
I would ask you all to be patient in seeing the results just as I'm having to be. Having said that, I fully agree that especially some of the high-performance verticals are going to be strong for us, and I expect to see enterprise continue to be a strong vertical for us.
Your next question comes from Erik Suppiger with JMP. Your line is open.
One just point of clarification. Can you update us on the number of routing customers that you had in the quarter? Secondly, you talked a little bit about the impact of deferred revenues from the deals that were certified. Can you talk a little bit about what happened to your backlog? Did you have many deals in backlog that were a function of the getting qualified, and has the backlog come down now that you are qualified from the software changes?
Erik, I'll take the last piece for us. We don't disclose backlog, we're probably not going to get into that. I think our commentary did say that we felt good about momentum in the quarter, and we felt good about the demand across the business in the quarter. We're not going to actually disclose the backlog numbers.
Yeah. No, I agree with Ita on that. To answer your question on FlexRoute customers, I think I told you the year-end number last year was over 200. Rather than giving you quarterly numbers, we did do well this quarter. Let me just leave it as I think we're going to double this year.
Very good. Thank you.
Thanks, Erik.
Thanks, Erik.
Your next question comes from Alex Henderson with Needham. Your line is open.
Great. First I'd like to just clarify, did you say you expected the mid-25% type growth rate in the remainder of the year, or did you say that you expected the mid-25% type growth rate for the full year? I'm not sure I followed the exact language there.
Yeah. For the remainder of the year.
Remaining of the year. Great. The question I had for you is, you've had pretty spectacular growth internationally. It is up in the 80%-120% range. If I do my math right off of the comments you made about the percentage, 67% in the U.S. in the quarter, it implies about 120% growth in the international arenas. Can you talk about what's driving that? Is that enterprise business that's driving that? Is that service provider? Is it cloud growth from the cloud customers in North America moving to international projects? What's behind that, please? Thanks.
Yeah. That's a good question, Alex. Thank you. If you may recall, we started to make a lot of international investments. When was it? 2015-2016, in that timeframe. I think we're 18 months to two years later, we're starting to see the return on that investment, not surprisingly, it mirrors our five verticals in the domestic. Some of it is cloud, we're pleased with the traction we're seeing both in tier 2 service providers as well as enterprises. Global financials is a good chunk of it, too. The only vertical that probably there isn't nearly as much of internationally is tier 2 cloud providers. They exist more in the U.S. than The tier 2 service providers and cloud providers end up being one and the same for many international customers. That should give you a flavor.
I think the increased performance is directly correlated to good execution and good planning 18 months ago.
Great.
Good job, Anshul and Manny.
Your next question comes from Paul Silverstein with Cowen & Company. Your line is open.
Jayshree, can you hear me now?
Yes, much better. What happened there?
Don't know. I'll keep it simple.
You sounded like you'd been gagged.
I'll keep it simple.
Yes, please.
Any change in the pricing environment and in the competitive landscape, both with respect to commercial merchant vendors like Cisco and Juniper, et cetera, and with respect to white box solutions introduced by any of your customers?
I'll keep my answer simple. No change in pricing.
No change in competitive landscape?
The normal aggression in competitive landscape. No change, just continued aggression.
Jayshree, I apologize, but I just want to make sure I'm clear on this. You're not seeing any incremental pressure from Cisco or others, including white boxes?
Yeah. Hold on. I'll separate the white box question. I am not seeing any incremental pressure from my competitors except the normal aggression that I've seen all the last several years and quarters. Specific to white box, this is a customer strategy, not a competitive pressure strategy. As you know, we launched Containerized EOS, and we're fully committed to working with our customers on consumption models that can be virtual, container, or physical. Nothing to do with competition.
Jayshree, I appreciate that as a customer issue, but it translates into the same thing, right? To extent one or more of your customers go to a white box solution, that takes revenue away from you that you could have otherwise accessed. Again, I apologize. I just want to make sure you're not seeing any incremental uptake of white box solutions by your customers.
Just again, I am not seeing any difference in competitive behavior due to white box and white box adoption or rather disaggregated EOS. I'm not seeing any shift or change. It's the same as I told you before.
All right. No problem. Thank you.
Okay. Paul. Thanks, Paul.
Your next question comes from James Fish with Piper Jaffray. Your line is open.
Hey, ladies, good quarter. Is Arista winning routing deals as mainly direct replacements today of your competitors, or is it mainly new footprint wins? Jayshree, you talked last quarter about disrupting the campus, and I think we've gotten a ton of questions around how you're going to do that. Any insight, can you elaborate what the plans are there?
Okay. James, thank you for the question. On the routing question, as I said before, the first sign that the router market's been going through some tough times is the actual market's been shrinking. I think part of the reason that it's been shrinking is many of my competitive vendor peers have been talking about an architectural shift. I think it's a shift that's been going on for three to five years. The last three years in switching and now more in the switching side of LANs. We've been incorporating routing for some time to come, nothing new there. The new change is in the wide area side, where more and more of those Ethernet interfaces are moving to Ethernet from traditional SONET or T1 or ATM type of interfaces. In terms of new footprint versus existing, for us, it's all new. It's net new, right?
What we see in some cases is a customer's looking at a specific routing use case for peering or edge or core and still keeping their legacy routers. If it's a complete greenfield opportunity, it's brand-new footprint, both for the use case and ourselves.
Then the campus?
On the campus, I think I said this before, and I'll continue to maintain, Arista does not plan to participate in the traditional campus. As things evolve in the campus and they become more and more akin or aligned with Arista's different value add and differentiable capabilities, we're open to that.
Thank you.
Thanks, James.
Your next question comes from Simon Leopold with Raymond James. Your line is open.
Great. Thanks for taking my question. I wanted to talk a little bit about what happened or what's going on in the cloud vertical. I'm wondering if you experienced any sort of, well, I guess we'd call catch-up spend in the March quarter or your expectations for the June quarter, due to the pause while they were doing the certifications. If that was the case, can you quantify it? If it wasn't the case, can you help us understand why there wouldn't have been some pent-up demand? Thank you.
Simon, I wouldn't call it catch-up spend. I think we were hurt by the three quarters. We were harmed in some fashion by slowing down our certifications. While the cloud titans waited patiently and completed the certifications, they're always dual vendor, and I'm sure they bought other gear as well during that time. I'd say we're back to a new normal business now, where we've completed the certifications, and now they can deploy Arista more, in all of the use cases without having to worry about certifications. Anshul, you want to add something there?
Sure. The compute and storage build-outs in the cloud are happening at a steady pace, in Q1 for sure. You can see that as well for our products. Nobody's asked so far on the call, the good news is, the cloud customers are no longer constrained on these 100 gig optics.
Yes.
It's really not related to our certification, just that the rest of the components are also freely available.
I guess if there wasn't some catch-up, does this sort of mean that there's opportunities for you to continue registering good sales? Basically, we won't see a pause, in the coming quarters. We're steady as she goes now?
Yes, Simon, the way I look at it, and Anshul, correct me if I'm wrong, is the pause is in the past.
That's correct.
The present and the future look bright.
Thank you for taking the question.
Thank you.
Thank you.
Your next question comes from Steve Milunovich with UBS. Your line is open.
Thank you. Anshul, I wanted to ask you, how sticky are the cloud titan customers? I think there's a perception that there's really no loyalty on their part, and if somebody comes in with a better product that they fairly quickly switch, or at least in the new build-outs, they go a completely different direction, which given that you've got a high share, could not favor you. You've worked with these guys for a long time. I know you're expecting to stay ahead, but what's your sense of what the loyalty is and how difficult it would be for them to move to a different vendor?
Sure. It's a loaded question, but I would say the stickiness is not in a given hardware configuration. The stickiness is with the software, how they automate, how they integrate, and operationally. I do believe the stickiness with Arista EOS is very, very strong. This is not a customer base that is using a product that we ship as a standard product. This is a customer base that customizes it along with us, and for a reason. This is not a market where someone shows up next day with a product that is somewhat similar, maybe one month ahead of someone else, saying, "I'm ready now." That's not what convinces these customers. What convinces is something that will solve their day-to-day problems in automation or integration or routing or data center interconnect. I don't believe that the light stickiness you refer to is actually true.
It's a very strong stickiness with these customers. Again, tied to the operating system and their automation stack, not just the hardware.
Thank you.
Thanks, Anshul.
Your next question comes from Samik Chatterjee with JPMorgan. Your line is open.
Hi. Thanks for taking my question. Jayshree, in your prepared remarks, you mentioned the innovation you're driving on the disaggregated software solutions with the hyperscalers. Just wanted to see if you can help me think about the roadmap of monetization of those, is there applicability of those disaggregated solutions beyond the hyperscalers customers? Thank you.
Yeah, sure. Thanks, Samik. The hyperscalers are most advanced in adopting these kind of disaggregated solutions because you really need developers and development engineers. It's more a co-development, therefore it takes joint work from both sides and joint engineers. In terms of monetization, obviously we work with them closely to monetize both the work we're doing and also other use cases that tie into that. In terms of use cases outside of the cloud titans, I would say they're single-digit customers. There are very few that have the capability and the investment to do it, but certainly we're very open when they come to that category and work with them. I would say a select few service providers and the large cloud titans are probably the only ones who've shown both the willingness and the capabilities.
Okay, got it. Thank you.
Thanks, Samik.
Your next question comes from Mark Kelleher with Davidson. Your line is open.
Great. Thanks for taking the questions. Most have been asked and answered. Could you tell us how many 10% customers you had in the quarter? I know at the beginning you mentioned something about customer concentration. Many top customers were so much of a percentage. If you could just reiterate that'd be great. Thanks.
Mark, we don't talk about 10% customer concentration in the quarter. We certainly let you know at the end of the year. What I did say for the quarter is there were five verticals. Four of the five verticals contributed to our top 10 customers, which was cloud titans, enterprises, specialty cloud providers, and service providers. Financials was not in our top 10 customers.
You can't give us anything on customer concentration in the quarter.
That's what I gave you in my opening remarks.
Okay. Thanks.
Thanks. Thank you, Mark.
Your next question comes from George Notter with Jefferies. Your line is open.
Hi. Thanks a lot, guys. I guess I was curious about linearity in the quarter, 39-day DSO calculation. I think you guys are a little odd in that the mix of cloud titans, I understand, is a big driver on that DSO number. They tend to have longer payment terms, if I remember correctly. You had an increased mix of cloud titan revenue, yet the DSO calculation is at all-time lows. I'd love to know what's going on with linearity, and can you kind of walk us through the moving parts there? Thanks.
Yeah. I think if I think about the quarter, the linearity was reasonably consistent, right? We didn't see anything particularly different in the quarter. The customer mix is a driver, that'll be kind of varied throughout the quarter depending on the quarter. In terms of overall linearity, it was pretty consistent. It's a linear business, right, generally on a quarter-by-quarter basis.
Got it. Did you guys do better then on collections? Was that the motivator for the big drop in DSOs?
Yeah. It's timing of billings, I would say. I think if I think back to Q4, there were some service renewals that happened at the end of the quarter that would've been sitting in AR.
Q1 would've been affected by that.
Yeah, Q1 wouldn't have been affected by that. You could parse across this, like a lot of different reasons as to why it moves around a little bit, right? Obviously we do that as we drive the collections numbers.
Okay. Fair enough. Thank you.
Thanks, George.
Your next question comes from Tal Liani with Bank of America. Your line is open.
Hi. Jayshree, I'll ask a question and you'll yell at me like the Tesla call, and I'm going to be famous after that. I'll ask a question.
Thanks, Tal. I can't wait to hear the question.
I'm going to ask you, I want to understand what happened last year in 2Q and what happened this year in Q1, and I'll ask it in a certain way. If I look at Q2, I don't have a problem with growing 25% Q2, Q3, Q4. Q3 and Q4, the 25% year-over-year translates into normal sequential growth rates. That means you have tough comps, so the year-over-year goes down, but on a sequential basis, it's normal. Q2 is too low because it translates into 7% growth. Your guidance is 7% growth sequentially, and that's the lowest growth you've had before. That means that maybe there was some concentration in Q1, maybe some orders fell into Q1 instead of Q2. I'm trying to understand. First, going back to last year, Q2 was giant, right? The 50% suddenly accelerated to 50%.
Let's go back and revisit what happened then that caused it, what's happening now in Q1, is there any part of it that is related to product launches, meaning the 7500R? That's why we see this slowdown maybe into Q2. Not slowdown, just lower than seasonal sequential growth.
Yeah, exactly. I think they're all getting a little spoiled, Tal, when I have to start defending our growth rates at 7% off a very large base to be too low. I think you are right to point out that we enjoyed a tremendous amount of confluence of 7500, 100 Gig and routing, combined with the law of large numbers. I think we're reflecting our best efforts at a very good Q2 guidance and a very good year if we execute on all fronts. Remember, if you go back to 2015, '16, we had quarters that were at 7% growth on much lower numbers. I'll try not to disappoint you, Tal, but you should be pleased and proud of us.
I'm not, by the way, this was just a way to open the question. By no means, no complaints. If I could go back, it's not a second question, just go back to it. Can you talk about any concentration of the last four quarters of a new product in the 7500R, the routing? Does it play a big role in this acceleration of growth and now after four quarters, it's slowing down? Was there something else that caused this giant growth in the last four quarters?
The giant growth was a combination of routing, 100 Gigabit, and good cloud spend.
Got it.
The enterprise kicked in. Everything happened perfectly.
Yes.
If everything happens perfectly, you're right to expect more from us.
Got it. Good. Thank you.
All right, Tal. Thank you.
Your next question comes from Vijay Bhagavath with Deutsche Bank. Your line is open.
Thank you. Hey, good afternoon, Jayshree, Ita. My question, Jayshree, is a bigger picture question, which is, as the growth rate starts trending in line to investor expectations, any thoughts on M&A and inorganic strategies? Put the balance sheet to work, perhaps lever up, then look to chase growth inorganically. Thank you.
Good question, Vijay. I think I have been personally spending a fair amount of time on strategy, to be thoughtful about this is important. If you just go do an M&A and it doesn't integrate well into our EOS, you can actually set yourself back when you're a fast growth company. If you pick the right adjacencies that work with our DNA, work with our culture, and actually add upon our growth, that could be a positive. We haven't ruled that out. We continue to look for them, as you know, 90% of M&A activities fail. We want to be in that 10% that make it. It's a good feedback and good question.
Thank you, Jayshree. Thank you
one we keep studying.
Thank you.
Thank you, Vijay.
Okay, that was our last question. This concludes the Arista Q1 2018 earnings call. 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 investor section of our website.
Thank you for joining, ladies and gentlemen. This concludes today's call. You may now disconnect.