Welcome to the First Quarter 2019 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. As a reminder, this conference call 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 Yeager, Director of Product and Investor Advocacy. Sir, you may begin.
Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me on today's call are Jayshree Alal, 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 results for its Q1 ended March 31, 2019. 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 Q2 of 2019 fiscal year, industry innovation, our market opportunity, the benefits of recent acquisitions 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 ks and which could cause actual results to differ materially from those We undertake no obligation to update these statements after this call. All 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 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 Q1 2019 earnings call. Our profitability growth combination was once again demonstrated with a non GAAP revenue of $595,400,000 while non GAAP earnings per share grew to a record $2.31 Services contributed approximately 15% of revenue. We delivered non GAAP gross margins of 64.5 percent, influenced by a strong performance from both our enterprise vertical and services. We registered a record number of $1,000,000 customers in Q1, just as we did in Q4 2018, and we continue to drive our new customer expansion at the rate of 1 to 2 per day.
In Q1 2019, the Cloud Titan segment was our largest vertical. The Modern Enterprise segment is now consistently our 2nd largest, with financials in 3rd place, supported by a strong solid contribution from our Metamako acquisition. Tier 2 cloud specialty providers and service providers came in at 4th and 5th place. In terms of geography in Q1 2019, the international contribution was 26% with the Americas coming in at 74%. We delivered 2 major new product announcements during Q1 with the 7,368 spine that we developed in close collaboration with Facebook, enabling both our flagship EOS as well as Facebook's OS to be supported on the platform.
We also introduced the 7,130, the first low latency, high precision network application platform. We're pleased with the increased acceptance of our software subscriptions with a record quarter for CloudVision having doubled our bookings from Q1 2018. While 2019 is off to a decent start, we are experiencing somewhat of a speed bump in Q2 2019. We saw less than the normal order strength in late March and the month of April. We are therefore forecasting slower growth in Q2 2019 from our normal and historical patterns.
Some of the contributing reasons for this are: 1, the massive cloud titan providers fulfilled in 2018 have led to a period of absorption in the first half of twenty nineteen. In particular, 1 Cloud Titan has placed most orders on hold for Q2 twenty nineteen. We note the lackluster performance of the service provider vertical and this we forecast this to continue in Q2 twenty nineteen consistent with industry trends. To put the volatility of the cloud spend into perspective, as I have shared with you many times, cloud titans typically give us 1 to 2 quarters of forecast. And this time, we're seeing a decreased demand in the first half of twenty nineteen compared to 2018.
Meanwhile, our enterprise momentum is healthy and very much in its early innings. Our investments from prior years to the present are now paying off. These enterprises typically require contracts, training as well as the deployment of Arista's new programmable SDN technologies and can take typically a year or more in sales cycles. We do expect 2019 to be a crucial year for both the enterprise data center and campus in terms of customer acceptance. As we look ahead, our new product introductions are slated to ramp in the second half of twenty nineteen, and we expect this to create uptick in demand.
You will of course hear more about our new product pipeline and customer momentum at our June Analyst Day. But in summary, we foresee a bright opportunity ahead in cloud area networking in the second half of twenty nineteen. Personally, I'm excited by our prospects here as customers migrate to a cloud led strategy with their unwavering belief in Arista's superior quality and technology. And with that, I'd like to turn it over to Ida for more financial metrics.
Thanks, Jayshree, and good afternoon. This analysis of our Q1 results and our guidance for Q2 'nineteen is based on non GAAP and excludes our non cash stock based compensation impacts, certain acquisition related charges and other non recurring items. A full reconciliation of our selected GAAP to non GAAP results is provided in our earnings release. Total revenues in Q1 were $595,400,000 up 26% year over year and above the midpoint of our guidance of $588,000,000 to $598,000,000 Service revenues remained strong, representing approximately 15.1% of revenue, down from 15.5% last quarter, reflecting a healthy level of renewals for the period. International revenues for the quarter came in at 156,000,000 dollars or 26 percent of total revenue, up from 24% in the prior quarter.
Overall gross margin in Q1 was 64.5%, above the midpoint of our guidance range of 63% to 65% and up from 64.1% past quarter. Gross margin in the period benefited from healthy enterprise and service contributions combined with a continued focus on cost optimization. Operating expenses for the quarter were $160,700,000 essentially flat to last quarter on an absolute dollar and percentage of revenue basis. R and D spending came in at $106,500,000 or 17.9 percent of revenue, up slightly from last quarter. We continue to see significant new product related NRE and prototype spending in the period.
Sales and marketing expense was $43,600,000 or 7.3 percent of revenue, again essentially flat to last quarter with increased headcount offset by some reductions in other sales costs. Our G and A costs were $10,500,000 or 1.8 percent of revenue, down slightly from last quarter. Our
operating income for
the quarter was $223,600,000 or 37.5 percent of revenue. Other income and expense for the quarter was a favorable 11,200,000 dollars and our effective tax rate was lower at approximately 20%. The lower tax rate primarily reflected the finalization of certain tax reform positions based on updated IRS and regulatory guidance. This resulted in net income for the quarter of $187,700,000 or 31.5 percent. Our diluted share number for the quarter was 81,200,000 shares, resulting in a diluted earnings per share number for the quarter of $2.31 up 39.2 percent from the prior year.
Now turning to the balance sheet. Cash, cash equivalents and investments ended the quarter at approximately $2,200,000,000 We generated $170,000,000 of cash from operations in the quarter, expecting strong net income performance, offset by new product related working capital increases and a reduction in overall deferred revenue accounts. DSOs came in at 41 days, down from 51 days in Q4, reflecting strong collections activity and the timing of billings in the quarter. Inventory turns were 2.5 times, down from 3.3 times last quarter. Inventory increased to $347,200,000 in the quarter, up from $264,600,000 in the prior period.
This primarily reflects increases in raw materials and finished goods as we ramp the supply chain for new products. Our total deferred revenue balance was $536,500,000 down from $587,200,000 in Q4. Our product deferred revenue balance decreased by approximately $80,000,000 in the quarter, reflecting customer acceptances of new features. This trend is consistent with 2018 and we also had a significant reduction of product deferred revenue in the first half of the year. Accounts payable days were 38 days, down from 40 days in Q4, reflecting the timing of inventory receipts and payments.
Capital expenditures for the quarter were $5,200,000 In addition, we announced today that our Board of Directors has authorized a 3 year $1,000,000,000 stock repurchase program. This allows us to repurchase shares of our common stock opportunistically and will be funded from working capital. Now turning to our outlook for the Q2 and beyond. As we look forward, we believe that we remain well positioned with our key cloud customers and are focused on expanding our presence in the enterprise and other verticals, especially as we bring new products to market in the second half of the year. While we executed well across all key financial metrics in the March quarter, we saw some shortfall in demand at the back end of the period, primarily from our service provider and cloud verticals.
Our 2nd quarter guidance assumes this trend continues through the June quarter, and we are managing the business on the assumption there may be some impact to the full year. On the gross margin front, we would reiterate our overall gross margin outlook of 63% to 65%, with customer mix being the key driver and indicating towards the upper end of the range for Q2 2019. We continue to invest in the expansion of the business, including the addition of sales headcount and resources. We believe that with reasonable top line growth, we can continue maintain operating margins at or above the previously discussed 35% range. With this as a backdrop, our guidance for the 2nd quarter, which is based on non GAAP results and excludes any non cash stock based compensation impacts and other non recurring items, is as follows: revenues of approximately $600,000,000 to $610,000,000 gross margin of approximately 64% to 65% operating margin of approximately 36%.
Our effective tax rate is expected to be approximately 21% with diluted shares of approximately 81,700,000. I will now turn the call back to Charles. Charles?
Thank you, Rita. 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 the Q and A portion of the Arista earnings call. Your first question comes from Jason Ader with William Blair. Your line is open.
Should we come back to Jason?
All right. Just one moment here. Jason Ader, your line is open.
Operator, we still don't hear anybody.
Sorry, the LeaderView actually, I'm frozen here. Just give me one second, sorry. Your next question comes from Tasia Vikankesh. Your line is open.
Thanks for taking my question. I did want to dig in a little bit more into the 2Q guidance. Given that in 1Q cloud titans were still the top vertical, should we think that this is basically one cloud vendor and the others are pretty healthy? And then I also noticed that the Tier 2 cloud in terms of ranking is a little bit below where it used to be. So are you seeing weakness there as well?
And service provider, I think, was weak in 2018 also. So coming off somewhat of a weak base, so perhaps you could talk about what's going on there as well? Thank you so much.
Thanks, Tejas. I think you successfully combined 3 questions in one. I'll do my best to answer all 3. I think in terms of cloud titans for Q2, one in specific is going to contribute greatly to our different guidance than was expected, but it isn't limited to 1. There are multiple in there.
Some are doing well and some are not. So if you add the puts and takes, it's overall a net negative. We still expect it to be the number one vertical in spite of everything. It's a strong vertical for us. We see a lot of demand.
We see strength in products. We are competitively very strong and superior there. In terms of their Tier 2 cloud specialty providers, they continue to do okay. I think the message you should read there is that our enterprise and financials are stronger, not so much that the cloud specialty is weak. And that was to be expected as we start getting broader in the enterprise and as the Metamako acquisition came in.
Service providers, nothing new, you're right. 2018 was a disappointment as we said so in the last call. And it's an industry trend and Q1 was no different and I'm not sure Q2 will be any different. I expect that to be the last vertical in the segment.
Next question?
Your next question comes from Jim Suva with Citi. Your line is open.
Thank you very much. I believe, Jayshree, you mentioned that you typically get 1 to 2 quarters of visibility from your cloud titans. So at this point when we're talking here today in May, have they given you new indications that the digestion will be completed as we kind of exit the June, July time period? Or is it still a little bit of risk or uncertainty? We're just trying to understand your conviction for the second half of the year.
Thank you.
Thanks, Jim. I think we're still forming our conviction for the second half of the year. We don't have a direct answer. As you can tell, we have 6 weeks of data, 6 weeks or even a quarter don't make a trend. We do believe the digestion will complete by the end of Q2.
What we don't have clear visibility to is the new demand for second half of the year.
Thank you so much for the details. It's appreciated.
Thank you. Thank you.
Your next question comes from Mitch Steves with RBC Capital Markets. Your line is open.
Hey guys, thanks for taking my question. I just want to follow-up on the revenue trajectory. Last quarter, you guys made a public statement saying that you were comfortable at least with the consensus estimates for the full year. At that time, it was kind of around 21%, give or take. Is that still the case?
Or should we assume that the numbers should come down from that?
Mitch, first of all, I think the numbers should definitely come down for Q2. And for further detail, I think we would want to be we're watching this closely. We want to be vigilant and we really don't want form an opinion until we have more data and can make one definitively. So things were fine when we talked to you at the last call on Valentine's Day and much of the change happened in the second half of March.
Got it. And then just one quick one on the buyback, just a clarification there. It says opportunistic there. What's like the rough metric you guys are using to I guess internally in terms of what you believe opportunistic is in terms of buying the stock?
Yes. I mean we haven't disclosed those externally. We're not planning to disclose that externally. I mean again we're putting the facility in place so that we have the freedom to buy back the stock when we feel it's the right time, but we haven't set any hard limits on what that will be.
I think it's important to look at this as a framework and then the specifics will happen as they happen.
Got it. Thank you. Thanks, Chris.
Thank you, Mitch.
Your next question comes from Ittai Kidron with Oppenheimer. Your line is open.
Thank you, ladies. I guess going back to the cloud, Jayshree, I understand the pause. I guess maybe you can help me get some comfort that this is a pause and not something else. How do you what is it that gives you comfort that this is not a design loss? Can you potentially tie Historically, you've also mentioned that you always mentioned that you're very tied very closely.
You have people actually working at your customers, at your large cloud customers on premise. So they can see the builds, they can see when something runs perhaps a bit too hot, too cold, a bit too far from a build standpoint. So I'm just again trying to understand maybe you can give us some color that makes me feel that this is again a speed bump and not a loss of design or change in architecture or something else?
Yes. Fair point, Ita. Well, as you know, things were fairly linear when we talked to you in February. In fact, we were feeling quite confident. And we experienced a sudden change in mid March and a sudden slowdown in orders, especially from the cloud titans.
So while I would love to give you comfort, we are watching, we're not concluding. 1 quarter for that matter 6 weeks don't conclude a trend. But we felt it was really prudent for us to reflect that the health of the Cloud Titan business suddenly shifted in 6 weeks, right? So in terms of answering your question on market dynamics, we don't believe they've changed. It's important to note that we're not experiencing any competitive dynamics that are different from the normal cycle.
We continue to gain share and have a tremendous opportunity both in the cloud data center and new markets like the campus. So I wouldn't read anything into the 6 weeks except, as I said, especially 1 cloud titan specifically slowed down and paused most orders in Q2. And those kind of things have an impact on our guidance.
Very good. Good luck.
Thank you, adjusted.
Your next question comes from Alex Kurtz with KeyBanc Capital Markets. Your line is open.
Yes. Thanks for taking the question. Just to beat a dead horse here, obviously. You guys have had cloud titans in your what caught you guys off guard as far as either rolling up the forecast from the sales organization and not seeing this coming because obviously there's been volatility in the past with these accounts. And I think we're all just trying to understand what changed from kind of your prior process around pipeline management?
Alex, that's a good question. I'm going to ask Anshul, who's the closest, our newly appointed COO, but the one who lives and breathes this daily to give you a color. Anshul, do you want to say more?
Sure. So Alex, we are continuing to win in various roles for the cloud companies, both within the data center as well as DCI. There's really no real change there. However, some of the cloud companies are spending in Q2, but some are just not spending. And that was a very hard shift that they made in late March, as Jayshree mentioned.
That's all that there is to it. We still work very closely with these companies. The joint R and D is great, like you saw with our co development with Facebook. So the previous team, there's no real shift in designs on architecture. We're doing very well.
They're still winning all the designs that we have been winning and more. But some of these companies simply pause, absorbing their own inventory buildup, and hence they're just not spending.
Okay. All right. Thank you.
Thanks, Alex.
Your next question comes from Rod Hall with Goldman Sachs. Your line is open.
Yes. Thanks for the question guys. I guess I won't beat the dead horse anymore. I want to ask about the
Thank you.
I do want to ask about I think the comment you've made before Jayshree suggested that maybe you're rethinking the full year growth though. And I just want to be clear that you at this point, you guys may come back to us with an update on what you think that growth is? And then the second question I have is on service providers. I kind of thought service providers, you felt that it bottomed out and you're calling it out as a little bit of a negative in the guide. I don't know, is it a small negative or is service providers continuing to weaken out from under you in a way that you maybe didn't anticipate?
Okay. Yes. Rod, I think first of all, thank you for not asking the same questions. So at least we have some diversity and understanding. We've answered it already as best we can.
Specific to the full year, Ita, I don't know if you want to comment, but I think at this point, this concluding the full year with 6 weeks of data would not be correct. We're concluding Q2 from a guide and we'd like your patience and we'd like our vigilance in deciding how it flows through the year. Ita, you want to comment on that? Yes. I think Rob, the only thing
I'd add is I think from a spend perspective, from a terms of managing the business, I mean, we are we obviously, we see what we see for Q2, but we are managing that cautiously as we look to the back half of the year. Again, not because we necessarily have any clear visibility to plus or minus there, but we just think that's prudent. So you will see us kind of invest on the sales side and drive some leverage on the R and D side and help kind of manage earnings and EPS until we know where we stand.
Yes. And regarding service providers, no, I would say it contributed a little bit to Q1. We expect it to contribute a little bit to Q2, but the largest shortfall was due to the cloud titans.
Any could you get any update on campus? I mean, I know you won a couple of people last time, any updates there?
Well, I think, I'd say 2 things. You'll hear more about this from our June Analyst Day. We want to get into more detail there. But the two things I'll generally say is the Mojo acquisition has been very successfully integrated and that is playing that we're seeing a lot more activity in campus from that. But we're also seeing a lot of fundamental cognitive activity.
Customers are really liking our approach to a 2 tier campus design, much more focused on client steering, better service assurance, native open config support, our X3 Splines that our competitors are playing catch up to a year later has been very well received and deployed. And finally, cloud vision for the campus is really coming onto his own. So more in June, but a very promising start.
Okay. Thank you.
Thank you.
Your next question comes from Paul Silverstein with Cowen and Company. Your line is open.
Jayshree, I'm going to ask knowing what the answer is, but can you give us any sense for how much revenue you can generate in campus, either in a range or point number, what you're thinking for the year?
Paul, I actually do want to answer that question, but can I do so at the Analyst Day?
That's what I figured.
Better than saying never, right?
I appreciate that.
Thank you.
Then I'll apologize if I may. I am going to go back to the question that's been asked again. And my simple question is, you referenced one particular cloud titan is going cold turkey and the others, I don't know if you were referencing all the others or most of the others as having paused. The material
Sorry, let me just correct you, Paul. We said one particular cloud titan put most of the orders on hold in Q2. But we also said some of the cloud titans are doing well in Q2. And then I think 1 or 2 others are having put their orders on hold, but are not doing as well as we'd expect them to. So if you sort of balance the pluses and minuses out of the 5 Quad titans, we had 2 doing well, 2 not doing well and 1 neutral, something like that.
All right. And the difference between the 2 that were somewhat soft and the one that was, it sounds like just stopped. With the other 2, you think there's also digestion of previous deployments as they catch up to demand or there's something different going on there?
No. We don't think it's all related to digestion. We think it's a combination of digestion and their own decisions on how to spend CapEx.
And you think the CapEx decisions are just timing decisions or something else?
Yes. When do they put their new data centers? When do they spend? When do they have leases and etcetera? And generally, we don't correlate exactly to a quarter, but eventually we correlate, meaning you can see a significant shift from all the earnings calls you've seen on the cloud titans in the CapEx spend reducing from 2018 to 2019.
So absorption the completion of absorption will affect us some, but we would also like to see them spend more in 2019 and currently they're spending less, some of them.
Okay. And just one quick final question for me. On the service provider piece, I'm a little bit surprised to hear you
call it out in the
sense that service provider has been, if I'm not mistaken, has proven to be more challenging than you all thought from the get go. That doesn't sound like it's new and different. So when you talk about softness in service provider, assuming softness versus your expectations, and I assume that in turn at least implies that it softened even further than the previous challenge you found in terms of how far, how fast your penetration, I mean, you're a new player in the market when you first came in, for you should all be share gain. The total the nature of in demand should be relatively less important in terms of your progression. I recognize it's not immaterial.
Yes. But again, the simple question would be, did it soften further?
Yes. One word answer to the line with
the question.
One word is yes.
Okay. I appreciate it. Now I'll pass it on. Thank you.
Thank you, Paul.
Your next question comes from Simon Leopold with Raymond James. Your line is open.
Thank you very much for taking the question. So I wanted to rather than talk about revenue trends, maybe see if you could shed some light on your expense trends. And specifically where I'm going with this line of questioning is to get a better sense of really what you need to do to expand markets. So to get beyond the cloud for things like success in campus, I noted you had relatively high sales and marketing back in the December quarter, a little bit lighter this quarter, but the trend is higher. Help us understand what you need to do to broaden your marketplace and be successful in areas like campus from an expense perspective?
Thank you.
Sure, Simon. I think Manny covered this and Anshul, maybe you want to add to it. But I think there are 3 things we are doing and we need to continue to do in the campus to get stronger. The first is we just have to invest more in enterprise coverage across the world. We're stronger in the U.
S. And internationally, but this is a global footprint. Every single major company has a campus. So we've got tremendous TAM there and tremendous opportunity and we got to put more feet on the street. So watch us continue to invest there.
And I think Canvas will be actually more of a horizontal opportunity for us more than just a vertical opportunity. So that's one. The second and important thing we have to also do is, win quickly with the customers who are most familiar with us, the 5,000 customers who know and love and appreciate EOS and the quality and the single binary image and the cloud vision, state oriented management and change control, this will be an important watch for us to have customer wins there because they obviously have already worked with us. And the final is not everything can be a direct customer touch. You will see Manny and Anshul and the team investing heavily in a very, razor sharp focus on channels.
Not all channels are equal, but a combination of elite channels as well as regional channels, different geographies and perhaps even some systems integrators will be important. Anshul, do you want to add to that?
That's pretty much it. And we'll talk more about this on the Analyst Day as well when we talk about campus overhauls.
Any chance we could maybe get a little bit of quantification around the rate of hiring or rate of expense growth we should expect for the year, what you're budgeting for?
I think from a budget perspective, it's going to be double what we did last year in people.
Yes. And I think what you should expect, Simon, is we'll at least for the foreseeable future, we'll look to kind of leverage drive some leverage in R and D to kind of offset that incremental spending on sales and marketing. And then we'll see as the top line kind of we see what happens at the top line, we can we'll revisit that. But I think sales and marketing go to market investments are the priority from our perspective at this point.
Great. Thank you for taking the question.
Thank you, Simon.
Your next question comes from James Faucette with Morgan Stanley. Your line is open.
Thank you very much. I wanted to try to avoid killing a different horse, but I'm going to change topics. So the question I have is like when you look at your non camp or your non cloud titan non service provider customers and that group you have indicated that those continue to do well. I'm wondering if you can give some color in terms of makeup of customers, if that's changing at all and what's going on from a geographic basis and where you're maybe seeing strength or kind of how that's evolving on a geography by geography basis? And then just a quick other question for Ita is that versus our model at least, your tax rate was a lot lower this quarter than we had modeled.
And I'm just wondering if something was happening there and how we should think about that going forward? Thank you.
Yes. Maybe I'll take that one first. So we did finalize some tax positions around GILTI and some other stuff that came out of the tax reform this quarter, and we got solid reduction. So it was actually a 20% in Q1. I think structurally, over time, it's probably higher than that.
We guided 21% for Q2. I think that's probably a good place to be until we see how it settles in. But it's come down off of we were in a 61.5% type range, so we've come down from that. So I think 21% is probably a good place to be now.
Okay. Okay. Thanks.
Thanks, James. To answer the question, I didn't have all the information on my fingertips. But what we're seeing is a very healthy uptick in logos, both in the United States as well as in EMEA. So, new logos are trending well in Q1 and we expect that to continue through 2019. In terms of new verticals, we don't see a trend, but we're definitely seeing strength in media entertainment, financials, healthcare.
These tend to be our top 3 verticals, I think, at the moment. And no reason we wouldn't start seeing more in education and some of the other places as well. High-tech enterprise generally is a strong vertical for us. So I think we're continuing to make our verticals horizontal, if you will, by get participating in more customers and more mid to large enterprises. Anshul, you had a good statistic on how many Fortune 5000 and Global 2000s were in this.
That would be a good data point.
Sure. At this time, roughly 25% of the Fortune 500 are risk to customers and just under 20% of the Global 2,000 are risk to customers and these statistics have been improving every quarter. So we are winning in the broader enterprise as well, not just our initial verticals.
Yes, that's very promising.
Thanks guys.
Thanks,
Troy. Your next question comes from Tal Liani with Bank of America.
Your line
is open. Hi, guys. First, I always thought that making us work on Valentine's Day evening is a bad karma and now I got my confirmation for that. I want to ask yes, yes, next time don't do it that night. Next, I want to ask a question on your routers.
You said before that service providers have still difficulties to accept or to take your vision for the routers that you're seeing more difficulties to sell routers to service providers than you had anticipated. Can you give us an update on what's their vision and if there's any change in the willingness of providers to take your 75R? Thanks.
Yes. No, that's a good question, Tayo. So I think there's really a fundamental difference between routers and routing. Routers were built at a time where you had different kind of LAN and WAN interfaces, generally low port density, generally 10x to 100x the price per port and generally custom ASICs. And what Arista has done is to shifted that to modern merchant silicon, whether it's Jericho or Jericho Plus or Jericho Next Gen in the future and cut down the number of layers.
And but service providers, unlike the cloud providers, have needed more time to operationalize it. They believe the strategy. They can't go as fast on the implementation. However, we have had a success with a couple of use cases. Anshul, you want to comment on that?
Sure, absolutely. Look, the RFP cycles and the contract cycles are fairly long for the sales force. So we do have lots of international activity, but the sales cycles are longer. In the U. S, the MSOs are steady state with us.
So we do well over there. We do well in the telco cloud, which is the data center part of the telcos built. But the rest of the telco is what's been slow.
Yes. And because they have an old RFP and we have a new RFP. So they haven't jibed.
Got it. Can I ask a follow-up question on something that everyone asked, but I have it? I want to look at it differently. There is one big customer that grew 100 plus percent for you and it will we will understand if that customer is pausing because it's abnormal to see this kind of growth. The question is, what is the growth in cloud in aggregate if you remove that specific customer?
In aggregate, did this group grow or not grow this quarter or the guidance, I mean?
Yes. I don't know that we're going to break that out at this point, Tal. I think the concentration on a single customer is probably appropriate, but I don't know that we're going to try to start breaking out the vertical inside of the vertical by car. That's yes.
Got it.
Okay. Thank you.
Your next question comes from Samik Chatterjee with JPMorgan. Your line is open.
Hi, thanks for taking the question. Hi, Jayshree. Hi, Itau. Hi, Anshul. So much easier question from me.
I'm just trying to kind of think about the switch product that you co developed with Facebook and kind of the implications around that given that at OCP, Facebook sounded like very enthusiastic about going through with implementation quickly as well as kind of, I mean, it sounds like a preferred position with the customers. So can you just help me think about kind of what the implications here in terms of what you're thinking in terms of market share opportunity and kind of what does this imply in terms of your position with the other cloud providers
as well?
Thank you.
Sure. Samik, this is Anshul. I'll take that one. We've often talked about joint development with our cloud titan at OCT was a perfect example of that. The world is no longer about build versus buy.
The cloud companies have too many projects to do and very few people to do those. So they do want to build and buy and they look for the right partners to do these joint developments with. And as you saw, we do have a preferred position there. This is one of the examples of things we work on. We do work on similar projects with other cloud customers as well.
Some of those are never talked about publicly, but we feel very good with our position there as well. So to the earlier comment, we do very well with these companies. So this is not to avoid mean that we are losing designs or anything like that. I think we're doing very well technology wise. It's a matter of spend that did not align.
But you're right, it's a great opportunity for us and I think we are best positioned in the overall market to capitalize on that.
I think this is a very exciting example of joint collaboration, which served Facebook well, but also serves all of our enterprise customers well. We've turned around and seen a lot of activity with enterprise customers with this product. So it's been very good.
Yes, great. Thank you.
Thanks, Samik. Thanks, Samik.
Your next question comes from Jeff Kvaal with Nomura Instinet. Your line is open.
Thanks very much. I'd like to stick with the cloud type. Let's go
a little bit further out.
I think one of the things that we have talked about as a group in prior calls is rising complexity of some of the cloud titan networks. Can you talk a little bit about to what extent that is helping you now? Are there future design topologies that are in the works that should be helpful in the future? Or conversely, is that a risk if other rival vendors are able to use those topologies as an insertion point? That'd be helpful.
Thank you.
Hey, Jeff. This is Jayshree. I think the one of the biggest virtues of the cloud titans is they remove the complexity and make it elegant and simple. But having said that, one of the virtues or one of the challenges they have is scale and they always need the uptime and availability. So when you look at what they've done, they've built this tremendously flat fat leaf spine network, except there's many tiers of leafs and many tiers of spines for different use cases.
I don't view that as complexity. I view that as removing the complexity to address many more use cases, which Arista and especially Anshul and the team have done very, very well. So when you look at spine, there's regional spine, there's DCI, there's security options, there's different types of routing use cases and obviously there are also at the very low end different types of leafs including integration with Facebook or Sonic in the case of Microsoft. Another area of great elegance is OpenConfig and the models we developed there. So I would say what's happened is the diversity of our use cases has led to many more examples of how we can work with the cloud providers and it's not just one design.
But the word complexity doesn't come to mind, the word elegance comes to mind. Anshul, I don't know if you want to add some more to that.
No, it's really the scale, right? The scale is getting larger and larger, and they have to design systems to manage that. But we do very well with these customers. So we're not worried about that. Yes.
Think it's simply that we've now gone from the first innings of all of this to the second or third finally. So there's many more left, but it's no more early days.
Well, maybe let me rephrase a little bit and say as these use cases grow, is there like a should we be expecting the pace of your ability to insert into these new use cases to pick up? And I'm thinking particularly of routing use cases, for example.
Yes. No, I think you can expect that and you should have seen that already in the last year when we did when we moved to 100 gig with many of our cloud titans, we also moved tremendously fast to routing and those use cases with FlexRoute. And the same thing is likely to happen as our customers move from just 100 gig alone to a hybrid combination of 104100. You can expect the familiarity in routing and the pickup to and the qualification time to compress.
Okay. Thank you all very much.
Thanks, Jeff.
Your next question comes from Eric Sepekert with JMP Securities. Your line is open.
Yes. Thanks for the question. So on Microsoft, I think last year it was 27 percent that was up from 16%. I think you had said that you thought you'd probably go back to 16% mid teens type percent contribution. Would you anticipate that it will still be in the mid teens contribution in 2019?
I don't know if we can guess that without knowing the second half, but I think it's safe to say it's around there for now. It's as good an answer as the one we gave you in February.
Okay. So you haven't changed your expectation in terms of the contribution from Microsoft. Is that correct?
Based on 1 quarter Q2 guide, no. We'll have to see the second half and then we'll know better. Does that make sense?
Yes, that makes sense. One quick one. Your deferred revenue came down some. Was the change in the deferred revenue, was that what you would have expected as you entered the March quarter? Or did the deferred revenue your recognition for revenue, did that change at all during the course of the quarter from your expectation?
No, I think we knew that we had and we talked a lot about this on the last call, right? We knew that we had some products that were waiting for customer acceptance. And I think there wasn't anything particularly unusual around that. And it's also kind of very similar to what we saw in Q1 last year, right? So I think the impact of that is pretty much as you'd expect.
The real big change, Eric, again, just to be completely transparent and direct was the change in demand for our products in late March April.
All right, very good. Thank you.
Thanks, Eric. Thanks, Eric.
Your next question comes from Sami Badri with Credit Suisse. Your
line is open.
Hi, thank you. Even though I'd love to ask a cloud question, I'm not.
So more specifically
Thank you for sparing
us. Yes. Actually it has to do with your margin guidance both on gross margin and OpEx. So if we look at sequential moves and it's interesting that your revenue guide in 2Q 2019 is coming down, which even like, I guess, you'd say further emphasize why I'm asking this question. Should we be expecting to see your operating margins start to level off below your historical record rates that you saw in the back half of 'eighteen, given your incoming investments into specifically the channel?
Or do you think you're going to still see the similar comparable type of operating margin profile as you booked in the back half of twenty eighteen, in the back half of twenty nineteen, in the back of a slower channel build out. That would be great just to get an idea on how we should be modeling margins in the back half of the year?
Yes. I mean, it all comes back to customer mix from a gross margin perspective, right? I mean, you're seeing an uptick in Q2 because we are seeing less cloud activity and it's waiting for enterprise and towards some of the others, right? And that's going to drive a higher gross margin. And obviously, that will flow through to operating margin, right?
So that's kind of a counterbalance to some of the top line slowness that we're seeing. In terms of spending, our goal is to continue to drive sales and marketing investments that we need to make and then we'll leverage our we'll leverage engineering, right? And we've been investing in the engineering side at a really fast clip over the last number of years. I think we've had a clip at the top line. So there is some room there for us to really to drive some leverage there and then use that to fund the sales and marketing.
And I think that's the strategy. Where that comes out exactly on operating margin, we'll have to see. I mean, you saw it tick up in the guide for Q2 off of the improved gross margin and then just some of the focus that we're going to put on OpEx.
Got it. And then just a very quick question on Mojo. What percentage of sales were direct and what percentage of sales went through the channel?
The Mojo business model was extremely channel. As it becomes more and more part of Avista, it would become more direct, although fulfilled by the channel still. So I would say today, given our Q1 is still predominantly influenced by Mojo sales itself, it's 80% through the channel. But if I had to forecast how it would look by the end of this year, it would be probably fifty-fifty.
Got it. Thank you.
Your next question comes from Aaron Rakers with Wells Fargo. Your line is open.
Yes. Thanks for taking the question. I'll try and slip into here as well. First of all, as you kind of speak to your customers, particularly as we move through March, I'm just curious, I know that there's a pause dynamic, but have you seen any customers kind of allude to a pause related to maybe new product cycle dynamics going into the back half of the year? Or is it truly just a digestion?
Or could we think about product cycle really being a kicker in the back half? And then with that also, I'm curious of a software only selling motion within the company. How should we think about that potentially evolving over the next couple of years?
Thank
you. Those are 2 very different but important questions. In terms of the dynamics we saw, it was pretty much the we didn't see anything different. But as it was just as we indicated, it was a pause, right? It isn't like they're waiting on new products.
Most of our customers are aware of our roadmap, not just for the year, but often multi year. But they still got a business to run and so they don't pause. They always mix and match the existing products with the new products. So we know how to drive that. We're very open and transparent about the products.
We're also very open and transparent about the migration. So we don't believe we saw any indication of that. However, we do feel that the excitement and enthusiasm of our new products is only going to help us, particularly in the campus and data center in the second half of the year. In terms of software selling, we started our cloud vision endeavors, I want to say 2016, right? 3 years into it, it's the first time we're really seeing the excitement in our customer base.
Many, many of our enterprise customers are choosing Arista because of CloudVision and EOS. And as you know, our products are great too, but they are just blown away by the manageability, the change control, the analytics, the automation, the macro segmentation features, the telemetry. So the software sales and more importantly, the software expertise in Anshul's systems engineering team driven by Ashwin couldn't be higher. He's putting a tremendous emphasis. I think he started this about a year ago.
And so I think every one of our leaders, as well as our systems engineer down to the customer support engineer is, I would say, a software expert first and then obviously all of the networking attributes. It's something that's been happening gradually, but particularly gratifying to see the results of it over this quarter with CloudVision have been double the bookings from Q1 2018.
Okay. Thank you.
Thanks, Aaron.
Your next question comes from Alex Henderson with Needham. Your line is open.
Thank you very much.
I was hoping you could talk a
little bit about where we are on the 400 gig transition. I assume that most of the transactions, probably 90% plus this year will be driven by 100 gig. But can you give us an update on what you're seeing between you and your competition in terms of the timing of acceptance of those products? And does that have any role in the timing of demand out of Web 2.0 cloud type?
Yes. So Alex, as you know, we're very excited about our market leadership in 100 gig and we hope we will transform that into market leadership in 400 gig to our technology as well. We introduced the Broadcom Tomahawk products. And I'm going to turn it to Anshul to talk about some of the acceptance we've had there. And we're not stopping.
We've got many more in the pipeline.
Thanks, Jayshree. Alex, the core development we did with Facebook was actually with Tomahawk 3 as well, but the form factor Express was 100 gig. 400 gig is exciting to cloud companies, but as we've talked about in the past, I mean, all of you, 400 gig deployments in the cloud are not feasible for many architectures without the availability of ZR optics. Those come to the market mid next year most likely. So as a result of it, the cloud companies will continue to deploy 100 gig, they'll qualify the new products and over time they will transition.
They're not waiting for the sudden migration to 400 gig. They either don't need it or they need the optics before they can migrate to a true 400 gig architecture.
I think the key that Anshul and I are really trying to communicate is don't confuse 400 gig ready with 400 gig being deployed. So Arista is really focused on 400 gig ready architectures already. We have them now. But when they'll get deployed will be a continuum in time, maybe this year, but much of it will be next year and the year beyond.
So just to be clear, there are a number of product cycles around 400 gig, around servers, around some other key components. And most of the other companies in the broader macro arena that you're competing in have indicated that they expected weakness in the first half of the year from cloud. You were bucking that trend. Now you seem to be more in line with the prior commentary from the other companies that are in the space. To the extent that they were expecting a resurgence in the back half of the year.
Is that something that we should expect from you as well?
I think we will refrain from what you should expect from us. We don't want to conclude that for the second half. We want to wait, watch and see. Stay tuned for more. I mean, I think we were very optimistic about Q2 in cloud spend as well and it didn't quite turn out that way.
So before we get optimistic on Q3 and Q4, we'd want to be more sure.
Alex, to complete that, we are ready with the products. But as I mentioned, the 400 gig transition is longer than what many of you expect. And we just have to go along with that rather than
being Can't change the fact that there's no optics to connect to it. Right. Right. So a 400 gig electrical only solution would be a weak solution. But Alex, to answer your question, yes, I think there's a lot of promise and is going to be a mix and match of 100 and 400 gigs for a long time to come.
Super. Thank you very much.
Thanks,
Adam.
Your next question comes from James Fish with Piper Jaffray. Your line is open.
James?
We can't hear James.
James Fish, your line is open.
Can you guys hear me now?
Yes. Now we can.
Okay, great. Sorry about that. Just actually going off of the last question, it sound appreciate that color. Maybe you could go into what optic forms those customers are actually taking on? Because I know there's a debate out there as to which of the 2 optic form factors.
Thanks.
We don't debate optics. We just support all the standard form factors. Andy Bechtolshein has been a very strong proponent of OSFP. I feel like saying all the time even it's a protocol. But there's just as many customers who want QSFP DD, Arista will support both and does support both.
Got it.
Thank you. Thank you. Thanks, James.
Your next question comes from Steve Milunovich with Wolfe Research. Your line is open.
Thank you. Yes, I wanted to follow-up on Alex's question. Last quarter, you guys were a real exception to the digestion that other companies were seeing with the cloud. And one of the reasons I think you gave was that you were finding new places in the cloud to sell to. And I don't know if that meant new tiers at current customers or new types of customers.
And I'm just wondering is that not happening? Is that part of what's going on here? Or did you just basically underestimate Microsoft as obviously a huge year last year, so pause wouldn't be shocking at Microsoft?
Yes. So, no, I think our use cases, including the Regional Spine and DSPI are alive and well. They're intact and we're continuing to make great progress with many cloud titans there. I think we underestimated the customer who paused in Q2 and even the customer who paused in Q2 didn't intend to pause in Q2. So we found that we've kind of found that out together.
And when we did, we are letting you know.
So you would, in a sense, didn't have the 3 to 6 month visibility that you normally would if even the customer kind of surprised themselves with this?
Yes. In this particular case, that would be true.
Yes. And I think it's just important to go back and remember that we've always said we have 1 to 2 kind of project visibility, but order book has always been shorter, right?
That's really good to distinguish. Yes. There's a big difference between orders taken and projects understood.
Got it. Thank you.
And by the way, just to add to that, there's been many times we've been positively surprised by order in the last few years and didn't forecast that either. So this is one of the rare times where the forecast came in the negative direction.
Your next question comes from Hendi Susanto with Gabelli. Your line is open.
Good evening and thank you for taking my questions. I want to ask about a forward looking question on the current Cloud Titan situation. How fast can a Cloud Titan resume a project that is on hold? And how much lag between that and the resumption of sales of Arista Networks products?
I'll take an answer to that, and I'm sure Anshul can add more color. I think they can resume a product as fast as they put it on hold. They can put things on hold in weeks and they can resume it in weeks to months. Is that correct?
Yes. Hendi, look, as we said, the cloud customers CapEx spending does not correlate with us in a quarter by quarter basis, because there's many things they spend money on, including building the data centers, buying service and so on. But in the end, in the long run, if they're adding racks and they're adding data centers across the region and they're peering, then they will need our products. So it's fairly easy for them to turn it back on as well. It's simply a matter of when they're ready to spend money on these projects.
Good for you. Thank you.
Thank you, Andy.
Your next question comes from John Marchetti with Stifel. Your line is open.
Thanks very much. I think I may get in the last question here tonight again. Just wanted to follow-up, Jayshree. You talked a little bit about the second half recovery or certainly the hopes for that in the second half. A big piece of that obviously being some of the new products that you intend to launch there.
How much of this, I guess, or what's new? Should we expect maybe to be focused on the cloud? Is it much broader than that? Just trying to get a sense of maybe the outlook for the second half, how much that relies on some of these new products versus maybe just some of the demand coming back a little bit for you?
Yes. Thanks, John. We saved the best for last as a question, I guess. I think we've always been an engineering company. We're very proud of our R and D and new products fuel our customers to enhance their networks, while existing parent products also carry the way for us in specific use cases.
So I think the new products, especially in the campus will definitely help. But new products in the data center and cloud will be a continuation and a continuum of what we've always done. So I think if there's any uptick in the second half that we didn't project yet, it would come more from new products in the campus, whereas new products in the data center and in the cloud have already been factored in.
Thank you.
Thank you, John.
Okay. Thank you all for your questions. This concludes the Arista Q1 2019 earnings call. For additional information on Arista and our quarterly results, please visit our Investor Relations website.
Thank you for joining, ladies and gentlemen. This concludes today's call. You may now disconnect.