Arista Networks Inc (ANET) — Q4 2018 Earnings Call Transcript

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 results for its fiscal fourth quarter and year ended December 31, 2018. If you would like a copy of the release, you can access it online at the company's website. During the course of this conference call, Arista Networks' management will make forward-looking statements, including those relating to our financial outlook for the first quarter of 2019 fiscal year, industry innovations, 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-Q and Form 10-K, and which would 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. 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, Chuck. Happy Valentine's Day, everyone, and welcome to our fourth quarter 2018 earnings call. In terms of Q4 specifics, our profitability growth combination was once again demonstrated with our non-GAAP revenue of $595.7 million, while our non-GAAP earnings per share grew to a record $2.25. Services contributed approximately 15.5% of revenue, consistent with it being typically higher as a percentage of overall revenue towards the Q4 end of the year. Our margins on a non-GAAP basis were 64.1%, influenced strongly by our performance from our cloud titan vertical. Overall, 2018 gross margins came in at 64.4%. In terms of customer trends, we registered a record number of $1 million customers in Q4, symptomatic of our enterprise vertical momentum. By the end of 2018, we had acquired a cumulative of approximately 5,600 customers with Microsoft at 27% of total revenue. The combination of an unprecedented year with multiple design wins, coupled with the release of deferred revenue due to legal certifications made 2018 a unique one-of-a-kind year at Microsoft. Our use cases are very diverse there. They transcend classical datacenter use cases to regional spine routing and DCI networking. So this often makes it difficult to directly correlate network spend to CapEx of server and storage spend. Without these collective one-time factors, Microsoft would likely have been more in the normal band of teens of revenue, like they have been in prior years. In terms of verticals, Q4 2018 and in fact throughout 2018, cloud titans represented our largest and strongest vertical. They were represented by our top five cloud titan customers. The modern high-tech enterprise segment is now our second fastest growing and our second largest segment followed by the tier two specialized cloud providers in third place, and the financial services and service providers tied for fourth place. Consistent with industry strengths, service providers have been somewhat of a low point for us, with negative annual growth after a very strong 2017. That said, we are pleased with our increased acceptance of our FlexRoute software licenses, growing from 200 customers in 2017 to 300 customers in 2018. Looking at the 2018 year in entirety, the 2018 international contribution was 28% with the Americas coming in at 72%, not too different from prior years. In terms of new products, Arista delivered a banner year of disruptive products, redefining networking with highly differentiated EOS stack, CloudVision management software, and flagship platforms. The 7280 and 7500 series have become the gold standard in 100 gigabit Ethernet cloud networking. In 2018, we also introduced substantial software innovations. These included containerization, tracers and analyzers. In particular, we have doubled our CloudVision management customers and our Any Cloud segmentation security software with APIs for AWS, Azure and GCP have indeed been transformational. Undoubtedly, 2018 has been a significant year for Arista with revenue of $2.15 billion and an annual growth of over 30%, with substantial contribution from our cloud vertical. At this time, I'd like to invite Anshul Sadana to recap our cloud titan strategy and really highlight our success here. Anshul?

Thank you, Jayshree. While we pioneered our cloud networking mission with 2-tier leaf spine designs, our customers are now using Arista products in a multitude of roles, both within and outside the traditional datacenter boundaries, which we term as PICs or places in the cloud. We are now successfully deployed in many PIC roles, including leaf, spine, bare metal, cluster interconnect, regional spine, DCI, metro interconnect, peering spine, private backbone, and extended long-haul use cases. Wire speed 256-bit MACsec encryption has secured all traffic that leaves the datacenter facility of our customers. In addition to recent speeds, Arista EOS is strongly preferred for the cloud's mission-critical use cases, due to superior quality, programmability via robust APIs and our EOS SDK. Our state-based real-time telemetry delivers world-class analytics, monitoring, and traffic engineering of these networks. All of these compelling advantages have created a collaborative partnership with our cloud customers as a build for next-generation architectures with ever-increasing workloads. Back to you, Jayshree.

Thank you, Anshul. Effective March 2019, I'm really pleased to announce the promotion of Anshul Sadana to Chief Operating Officer. In this expanded role, Anshul augments his present worldwide product management and customer-facing functions with platform engineering, manufacturing, and operations. Anshul, as many of you may know, has been a key pillar and contributor at Arista for over 11 years, demonstrating that keen unique sense of product depth driving our consistent differentiation in a typical Arista way. Please do join me in congratulating Anshul on his very well-deserved promotion. Arista continues to drive cloud area networking where the future of networking is not siloed to a switch or a router box alone, but in fact a software-driven place in the cloud. As we exit 2018, we believe we hold the number one market spot in 100-gigabit Ethernet switching share in port for the high-speed datacenter segment. As I mentioned last year, scaling the company and the team was a stated goal. We accomplished this many ways, including the addition of two senior officers to our executive leadership team, John McCool, our Chief Platform Officer and Manny Rivelo, our newly appointed Chief Customer Officer. We also successfully integrated our first two M&A transactions last year - Mojo Networks for Cognitive Wi-Fi in the campus and Metamako for ultra-low latency networking. Our employee bench strength increased to 2,300 in 2018, from 1,700 in 2017, while maintaining a very high bar for top-notch talent. What is increasingly clear to me is that Arista is gaining strategic relevance and has a seat at the table with enterprises seeking next-generation cloud area networking as a compelling alternative. And with that, I'd like to turn it over to Ita for more financial specifics.

Thanks, Jayshree, and good afternoon. This analysis of our Q4 and full year 2018 results and our guidance for Q1 '19 is based on non-GAAP and excludes all non-cash stock-based compensation impacts, losses related to our private company investments, charges associated with our recent acquisition, 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 Q4 were $595.7 million, up 27% year-over-year and above our guidance of $582 to $594 million. We experienced good overall demand in the quarter with ongoing strength across the business. Service revenues represented approximately 15.5% of revenue, up from 13.8% last quarter, reflecting a seasonally higher level of renewals in the period. International revenues for the quarter came in at $144.9 million, 24% of total revenue, down from 28% in the prior quarter. Looking at the year, international mix remained consistent on a year-over-year basis at approximately 28% of total revenue. This reflected strong growth in our international and regional businesses, offset by a higher mix of US deployments from our cloud titan vertical. Overall gross margin in Q4 was 64.1%, just above the midpoint of our guidance of 63 to 65, and down from 64.6% last quarter. This reflected a healthy mix of cloud titan revenues in the period and as expected, some incremental costs related to the previously announced trade tariff. While the operations team is making good progress towards mitigating these tariff-related costs, we expect to see some continued impacts for the remainder of 2019. In the interim, we will continue to pass a portion of these costs to our customers pending completion of the required supply chain changes. Operating expenses for the quarter were $160.1 million, up from $155.1 million last quarter. R&D spending came in at $104.9 million, or 17.6% of revenue, mostly flat to last quarter on an absolute dollar basis. This reflected higher NRE and prototype spending in the third quarter, offset by ongoing headcount growth in Q4. Sales and marketing expense was $43.8 million, or 7.4% of revenue, up from $41 million last quarter with increased headcount and related sales costs. Our G&A costs remain consistent at approximately 1.9% of revenue. Our operating income for the quarter was $222.1 million, or 37.3% of revenue. Other income and expenses for the quarter was a favorable $9.5 million and our effective tax rate was consistent at 21.4%. This resulted in net income for the quarter of $182.2 million, or 30.6%. Our diluted share number for the quarter was 80.93 million shares, resulting in a diluted earnings per share of $2.25, up 31.5% from last year. Now turning to the balance sheet. Cash, cash equivalents and investment ended the quarter at approximately $2 billion. We generated $296 million of cash from operations in the quarter, reflecting strong net income performance combined with improvements in supply chain related working capital and increased deferred revenue amounts. Overall, we generated $503 million of cash from operations for the year, which included the payment of the Cisco settlement of $400 million in the third quarter. DSOs came in at 51 days, down from 53 days in Q3, reflecting the timing of billings in the quarter. Inventory turns were 3.3 times, up slightly from 3.2 last quarter. Inventory increased to $264.6 million in the quarter, up from $216.3 million in the prior period. This primarily reflects increases in raw materials and finished goods as you ramp the supply chain for new products. In addition, consistent with last quarter, we maintained a further $14.6 million of inventory deposit recording another asset at the end of the quarter. Our total deferred revenue balance was $587.2 million, up from $529.9 in Q3. Our product deferred revenue balance increased by approximately $18 million in the quarter reflecting customer acceptance requirements on new products. The 2018 closing product deferred revenue balance was again essentially flat to the prior year and not a meaningful contributor to revenue for the year. There was, however, a shift in the customer makeup of the product deferred with Microsoft redesign qualifications representing a significant portion of the 2017 balance, as compared to a negligible amount of Microsoft product deferred at the end of 2018. Accounts payable were 40 days, up from 39 days in Q3, reflecting the timing of inventory receipts and payments. Capital expenditures for the quarter were $6.2 million. Now, turning to our outlook for the first quarter and beyond, we are pleased with our strong 2018 financial performance, with 31% revenue growth and 42% growth in earnings per share on a year-over-year basis. As we look forward, we believe we are well positioned with our key cloud customers and remain focused on expanding our presence across all of the verticals. Our revenue guidance for the first quarter are $588 million to $598 million, representing 25% year-over-year growth at the midpoint. On the gross margin front, we would reiterate our gross margin outlook of 63% to 65%, with customer mix being the key driver of where we operate within this range. While we remain cautious in relation to our spending ramp, you should expect us to make the investments necessary to support the expansion of the business. We believe given some reasonable top-line growth, this can be accomplished while maintaining operating margin in the previously discussed approximately 35% range. With this as a backdrop, our guidance for the first quarter, which is based on non-GAAP results and excludes any non-cash stock-based compensation impacts and other non-recurring items is as follows: revenues of approximately $588 million to $598 million; gross margins approximately 63% to 65%; and operating margin of approximately 35%; our effective tax rate is expected to be approximately 21.5%; diluted shares of approximately 81.4 million. I will now turn the call back to Chuck. Chuck?

Thank you, Ita. We are now going to move to the Q&A portion of the Arista earnings. Due to time constraints, I'd like to request that everyone please limit themselves to a single question.

Yes, thank you. Jayshree, I don't know if you guys - I'm not sure you debated this. But have you thought at all about providing some full year guidance for 2019 in terms of revenue?

Yeah, Jason, you can well imagine not only have we debated it, I think you all have debated it. If you look back at our five-year short history since IPO, we have never provided annual guidance. I think we made an exception once, when we felt that consensus was significantly different than our guidance. And therefore, we took exception to that, and wanted to course correct and let you know that it was way off our guidance. So I think you can safely assume that since we're not doing that, we want to go back to our normal mode of quarterly guidance and we're comfortable with your current consensus estimates.

Thank you.

Thanks, Jason.

Thanks for taking the question and happy Valentine's Day. Just to Jayshree and Ita here on this Microsoft contribution for 2018, obviously, that's well above what a lot of us were thinking might happen and maybe you could frame for us how cloud titans finished out for great teen, seems like maybe it was pushing 40% of revenue. I'd like to have you comment on that. And how should we think about cloud titan growth in contribution for the year? I know you're not giving guidance, but just help us frame that, because that's a significant upside for Microsoft and sort of our modeling of that.

Yeah, so thanks Alex. Happy Valentine's Day to you as well, we love you all. And what I would say in general is this is truly an unprecedented once-in-a-lifetime or one-of-a-kind year with Microsoft. We don't expect that to repeat. We would love for that to repeat, but we don't expect that. And we believe they will continue to be a 10% concentration customer in 2019, but will go back to a more normal percentage of our revenue. I think the cloud titans as a category did extremely well for us. All five major cloud titans that typically contribute to Arista as part of the top ten customers continue to make important contributions in 2018. We expect there to always be some shift in balance between the five and 2019 will likely be different in the contribution of the cloud titan. But I think you're right in assuming that as a category, we still expect them to be about a third of our revenue in 2019. And they were higher due to the Microsoft concentration in 2018.

Thank you.

Thank you.

Hi. Thanks for taking the question. Anshul, congrats on the promotion. I just had a question primarily on the prepared remarks that Anshul had about you seeing additional uses of Arista's product in parts of the datacenter and outside the datacenter with the cloud customers. That obviously has driven some of the strength here. How broad-based is that? Do you see more room with all the cloud titans as well as the tier two cloud providers, to see that expand more and probably you - that had to outperform their overall spend on networking even in 2019? Can you help us think about?

Certainly, Samik, you're right. There are many of the expanded use cases that we didn't join into. But as a result of us doing routing, encryption, and some of the DWDM products that we have this emitting colored wavelengths, we are now able to participate in an increasing TAM. In the past, you always considered us just as a switch, but we are now able to take on these higher lid. But in addition to that, it's not just a one for one displacement. These are new architectures that are significantly more resilient. The goal many of the cloud titans have, and even the smaller cloud companies just out of smaller scale, is to not focus on one network that is this mythical fifty-nine, but build networks that are parallel architectures, that are highly resilient and be able to do that with our leaf/spine architectures and some of the new use cases, whether it's peering or DCI or regional fabrics, the regional spines; and pretty much the same approach but expanding to a much wider area within a metro, 100 kilometers plus.

Okay. Got it. Thank you.

Thanks, Samik.

Thanks very much. On the tariff that you made comments on during your prepared comments and your outlook, did you mean to say that you're building in the tariff for your revenue outlook and was it the 10% or the potential 25% rate? And is that across all products or just those coming from China, because I'm sure a lot of products that may be assembled in Guadalajara or Florida could actually contain China parts. So can you just help us understand how you're navigating through the tariff situation?

Yeah, let me clarify and I'll pass it over to Ita, Jim. What we said in Q3 and we continue to reiterate in Q4 is the impact of tariffs is still very much there in our cost, because many of these components come from China. So even as you move to different contract manufacturers, you can have second derivative effects if you will. Arista's response to that was to absorb some of the cost, but also have a 3.3% tariff fee, assuming the 10% tariff increase. We have made no assumptions on the 25% increase, since there is still a lot of speculation there. Ita, do you want to add to that on the impact of that?

Yeah. I think it applies to products that have components that are actually tariff, right. It doesn't apply on the software and optic system and stuff. And, again, we're making plans, we have the plans for how we start to remediate that with the supply chain. It just takes time to execute on those plans; you don't move. It takes time to affect the supply chain movement. But we're working on that.

So 25% would be the same methodology as what you did in 10% I would assume.

Yeah. We haven't really thought it through or formulated a plan. We're hoping it never happens. But, yes, we would apply something similar.

Thank you so much for the details and clarifications. It's greatly appreciated. Thank you.

Thank you, Jim.

Thanks, Jim.

Congrats, ladies, and Chuck. Thanks, a great quarter. I guess, I want to go back to where we started again, which is the cloud. I just want to make sure I understand your comments, because I mean with Microsoft being 27% on the year. I think you made a comment to the effect that the more normal run rate was the percentage of Microsoft was last year, which was 16%. And so, that implies about 10% is through product defers and delayed certifications, and all of that. And since Microsoft has little to no presence in your product deferred right here right now, stripping that out, your core growth in 2018 was only 20% really outside of the deferred. And I guess, I'm trying to think, help me think about the titan vertical in general. Is that a vertical that grows below corporate average do you think for the year? Are there big parts in your footprint that you feel would be more competitive on the year and how do you feel about your ability to protect them? And clearly, when 400 comes along, there are a lot of vendors are making a lot of claims and you seem to be at the top of the hill. So, clearly, you're right on the target.

Wow, that was a loaded question. Ita, you want to clarify?

Yes, I try to portray in there, yes.

Yeah, you just succeeded. Thank you for the good wishes. Let me have Ita clarify some of the…

Yeah, maybe let's just talk about the deferred piece, just to make sure we're thinking about that the same way. I mean, at the end of the day, deferred revenue, product deferred revenue did not contribute to revenue for the year, right? So if Microsoft, the mix of Microsoft change, and obviously that resulted in Microsoft having a higher percentage of revenue, right? But also the deferred was backfilled with some other activities. So when I think about it on an activity basis, Microsoft's activity in the period was significantly below the 27%, not back to the teens, because we had some good use cases, et cetera, but significantly below that 27%, just to be clear. So when you think about transactional activity in the period, the deferred kind of comes out of that and we did backfill that deferred amount with some other customers, right.

And to answer your question on growth, we obviously don't expect Microsoft to have the same amazing growth in 2018-2019 that we had in 2018. But we fully expect the cloud titan category to grow well, if that makes sense. So I think there will be puts and takes in our other contributors and other customers, be it cloud titans or even some other tier two cloud providers who are going to greatly contribute to our cloud growth.

Very good, good luck.

Thank you, Ittai.

Thank you, Ittai.

Yes, thank you very much. And I'm hoping perhaps to ask the question that may be on many of our minds about web scale CapEx and you've touched on it a little bit today, and certainly in the past. But, look, the numbers do seem to be decelerating a decent amount. And I'm wondering if you could help us explain why there is a decent disparity between what the spenders are up to and your revenues.

Sure, Jeff. I'll take part of the question and I'd like my expert here, our new COO to take the other half. As we tried to explain, we're not able to directly correlate server spend with Arista or networking CapEx spend. And the reason is, obviously service spend connects to the first point of a network attach, which is typically a leaf switch, but what we're finding is many tiers of leafs and many tiers of spines. Anshul gave you some examples of regional spine, a core routing spine, a WAN spine, a datacenter interconnect spine—all of those examples and especially the MACsec security, none of them—and peering, none of them have a direct correlation to the first use case we just talked about, which is the server and first Top-of-Rack switch spend. So the one-to-one correlation is difficult. However, I think you can make a correlation if the overall spend is declining then obviously we'll also feel the impact of that, but it's hard to pinpoint and say, a server spend is declining, network spend is declining, it's not one-to-one. Anshul?

Jeff, I'll add a few things here. Number one, last year or the last few quarters, there's been significant volatility in memory prices for servers and that resulted in increased CapEx for many other cloud titans and also resulted in a reduction in cloud CapEx for many of the titans. That has no impact on networking, so as a result we are not correlated there. And second, when you look at the very large build-out of regions, datacenter facilities, all of that often gets counted out as CapEx, but obviously we're just focused on how much networking interconnect you need at different layers of different architectures and hence you'll see less correlation in the short-term. As Jayshree mentioned, in the very long run, these things can tie back, but they're not even associated within that one year, and hence the data, but otherwise we've done well technically with the cloud titans and we are happy to compete going forward as well. Thank you.

Anshul, do you think networking is gaining share inside of the overall web-scale CapEx?

I would say networking from our standpoint, not so I think it's very, very similar to some previous years. However, optics is a different ballgame, and as you very well know, 400-gig optics are slightly more expensive on a per gigabit basis compared to 100-gig—not per gigabit, per port, and I think that will change some of the equation if it is being allocated to networking, but I don't think our correlations get changed that way.

Thank you, and congratulations on your appointment, Anshul.

Thank you.

Great, thank you very much. Anshul, I wanted to follow up on your mention of 400-gig and that coming to market and implementation later this year and through 2020 and beyond. And as you're looking at that, what do you think the appetite is from your customers to mix and match 400-gig with existing 100-gig plan and—because I'm wondering how much opportunity do you see for footprint share shift among in your customers for that? And secondly maybe as you're talking about that, maybe you can also talk through kind of what the use cases are for 400-gig that you think will at least start things going.

James, I'm going to kick it off and then Anshul will get into detail. I think one of the things we have said consistently is that 100 and 400-gig mix and match is going to happen frequently. And in fact, with the exception of the cloud titans that are going to push us more on 400-gig, the mainstream use cases we see in 2019 are still heavily favored by 100-gig. And even as we go into 2020, when the optics become more available, I think you're going to see much more of a combination and that's going to favor Arista because of our incumbency and leadership position in 100-gig. Anshul?

Absolutely. Thanks, Jayshree. So just adding on to what you just heard, in networking, you do not introduce a new speed that's not backwards-compatible with the existing installed base, otherwise, you'll just never get to get it to work, which is how IPv5 died.

What is IPv5?

But if you look at 400-gig in the cloud datacenters and the way the architectures are going on, the hyperscalers are hyperactive with the next gen design and they all have their own problems to solve for different use cases where it's public cloud or storage or video or caching and so on. You can't just touch one intermediate layer and say, I'm done with my 400-gig upgrade, you have to upgrade end-to-end, so there's slow transition and hence the interoperability is important. I would say interop offer 400-gig uptake back into a DR1 QSFP28 is going to be very, very important even for cloud customers, that's the only way you connect back to the installed base, but because now you're able to touch multiple layers, it takes a long time - several quarters to several years to actually get that upgrade done.

Yeah, hi guys, thanks for the question. Congrats to Anshul as well. I wanted to start off, I guess and just since we've talked a lot about datacenter, just ask about campus and see if there's any update on that if you guys have any milestones that you might be able to give us in terms of trials, things like that - how it's going. And then secondly Ita, I just wanted to clarify your comments on seasonality around services; that was quite higher than we anticipated. And I'm wondering are you saying that that's more of a normal seasonal progression of services looking forward or is that an abnormal quarter that we're looking at here. Thanks.

Yeah, let me take that one first. I mean, I think the 15.5% is probably high, right. The Q4 tends to be a strong renewal quarter and there's some recognition of revenue that comes along with that, so I think back in the 14%, maybe 14 and change is kind of probably a better average for the year, is how you should think about it.

And Rod, to answer your campus question, it's too early for revenue. I think it will be more material in the second half, but we've seen an extremely strong desire to have a viable alternative to the incumbents, in quality, simplicity, cognitive capabilities, and automation. And I'm going to let our new Chief Customer Officer, Manuel Rivelo speak to it some. Manny?

Yeah, thanks, Jayshree. Rod, good to talk to you. So, Jayshree classified it correctly. It is early days and we see this being material in the second half of 2019, but the initial acceptance has been really well-received by the customers. And I think there's two categories for customers, and the first is our existing installed base. And that installed base is looking to extend EOS across their infrastructure into the campus, driving one management plane, cognitive management plane, one set of telemetry, one EOS. And they're really looking to for simplicity. They're looking for agility. They're looking for scale and they're looking for quality. The second type of customer running into are customers who haven't done business with that know we're approaching the campus space. And those customers are really looking at us as an alternative because of fatigue. They're seeing in the market segment basically 30 years of lack of innovation, 30 years of stagnant architectures and more and more boxes being pushed out instead of a unified architecture, so we're seeing great traction with those customers early days. But like I said it's early days; we got a long way with the portfolio and bring that to the customer base, but there's a lot of excitement there also. And then just to give you examples of when, I mean, we had various wins throughout the quarter in the campus. One was a million-dollar account, which is a multinational beverage company where we basically were driving our campus solutions into that and drove great success into that and we expect to see expansion going on there. And we've also had lots of wins where we began to integrate our spine architecture inside those use cases, and again for the same reasons—scale, quality, fatigue, et cetera.

Thanks, Manny.

Right, thank you. Jayshree, I know how much you love to be pinned down, so that we could wind up.

It depends by who? Thanks, Paul. Happy Valentine's Day to you as well.

Right, I'm probably back to action. So for the first quarter and the 25% of there about year-over-year guidance that you gave, how do you get there - could you help break it down by customer—I'm not asking by individual customers, but in terms of customer verticals, what drives that growth and then I have a follow-up question.

I think I expect to see a more normal concentration of customer verticals. I think all five will be represented in double digits. Cloud titans will, I think continue to be one; if I had to guess, I would say enterprise will continue to be two again, and then it's hard to forecast between three, four, and five. Does that make you happy?

No, not exactly. What I'm trying to get at is, I trust it goes without saying or maybe it doesn't that the customer verticals two to five, your cloud specialist - especially your enterprise service players et cetera that collectively you're expecting the growth rate from that group of customers i.e. the customers other than cloud titans, to increase and you're expecting growth from cloud titans to moderate, is that a fair assumption?

Yes and no. I'm expecting growth from Microsoft to moderate, but I haven't said I'm expecting growth from the cloud titan vertical to moderate.

So you're not expecting growth from your other cloud titans to moderate and from your cloud titan verticals collectively.

I didn't say that, no. But I think it's fair to say it will moderate with Microsoft, given the once in a lifetime unique year we had here in 2018. So with the exception of—

I have a follow-up question. Go ahead.

With the exception of Microsoft, we feel very comfortable with our growth in all five verticals; I think that's why - and Paul we can chat about this more, but we should probably allow the next question.

Can I just quickly ask you as a follow-up? Is there anything unique about the first quarter relative to the rest of the year?

No more than the normal seasonality, right. I think it's always a quarter that tends to be flattish off of Q4, I don't know if there's anything else particularly unique about Q1.

I appreciate that, thank you.

I think there are most similarities to Q1s with prior Q1, there is uniqueness. Thank you.

Hi, thank you. Can we just take a few moments, maybe just to discuss what you're seeing with service providers? Because the one thing the entire sector seems to be very hyped up about is 5G. And you're seeing it on the ramp side, but there seems to be a big disconnect when we get into the equipment side of the spectrum. Can you just kind of walk us through when you think SP spending towards equipment will start to ramp back up and is this a back half '19 event or is this a 2020 event based on your purview at this juncture?

Sami, I'll take a crack at it and I think Manny and Anshul may help me as well. Look I think given a very small presence in service provider, we don't believe we are affected by macro trends and in our view at least, the influence of Arista gear is not 5G-dependent, because we're really a backhaul for IP routing and ring switching and routing together and providing the scale of routes and IP tables and the ACLs that no one does. That said, I don't think - we think 5G is really a move away—400-gig is 2020; I think we think 5G is 2021. So from our perspective, we've got upside in service providers because we had a very strong 2017. We're disappointed with 2018 and that gives us a chance to grow faster in 2019. We're seeing tremendous activity both in the US and we have put more emphasis on international theaters. Manny, maybe you want to speak to that.

Yeah, no, just to add to that. In the use cases that we play and service providers whether it'd be Telco cloud and FEI or peering, we're doing quite well at executing across the globe in various tier I and tier II operators. In other use cases, the portfolio continues to run itself out. It's additional features to cover those use cases, but as Jayshree pointed out, we've also made investments in 2018 for better coverage both on the account manager side and on the SE side to represent those Tier I operators who are getting more fast as it pertains to our piece and proof-of-concept, so we think that that will bode well as we enter 2019 and beyond.

Got it, thank you.

Thanks, Sami.

Hello guys, thanks for the sweetheart print. We appreciate it. I wanted to ask a question relative to two dynamics and see if you could play them off against each other. So we're definitely hearing a lot of conversations about slowdown in server investments based off of a product cycles at Intel as well as some of the other cycles that are going on. That suggests a slowdown in cloud in the first half of the year and a reacceleration in the back half of the year, so part of the question is, are you seeing that kind of dynamic as well? And then the other side of it, there's a countervailing force, which we're hearing that spending on 100-gig is expected to double year-over-year in terms of port sales. So to the extent that we're seeing a doubling of 100-gig, are you gaining enough share in a 100-gig as a result of your dominance in that space, which I think is two times the share of the overall market - your overall market share? And does that offset the divot in demand in the first half in Web 2.0 due to those product cycles?

Sure, absolutely. Alex, great questions. And in terms of CapEx for the large cloud titans, we certainly don't have visibility yet into the second half. We would love them to forecast accurately as you very well know. On the first half, because we're in so many diverse use cases, we are getting a little bit decoupled in the short-term from the exact server spend. They might be buying fewer racks now, but they're still doing DCI but also other things and so on. But the same time obviously, if they spend more in the long run we could benefit. Now to your point on 100-gig spending or 100-gig ports are doubling - and I would emphasize actually 100-gig ports that are doubling, not the spend is because some of the next generation technology is now starting to show up in the market including some of our products, which are really being used not as 400-gig but more cost-effective four by 100-gig, and that allows customers to get many more ports than what they used to be in the past, but that doesn't change the revenue dynamics significantly. It just lowers the ASP and increased the port count.

But does it change share is the question.

That will depend on our execution, Alex. We've held on to the number one position for two years in a row; hopefully, this year will be our year.

Okay, thank you very much.

Thank you, Alex.

Yeah, thanks for taking the questions. And also congratulations on the good print. I want to go back to the router market; you mentioned in the prepared remarks you've gone from two to 300 FlexRoute customers. It sounds like one of your major silicon providers does a major release starting to ship in volume in Jericho 2 looking towards the mid-part of the year, which is very focused on the service provider market. So I'm curious, if we look out over the next 12 months, is there a natural expansion story in the router functionality that expands your opportunity set in that incremental growth driver going forward?

Thanks, Aaron. I think it's a really good question. I believe we have a national expansion even before Jericho 2, which has had to do with a lot of our FlexRoute features and the 50% growth of our customers from 200 to 300. So at least in 2019, I see that more immediate success will be not necessarily waiting for the next generation of silicon, but really going into these 200 to 300 customers and enabling the greatest success, many of whom are service providers. Now after that, the Jericho 2 cycle, which really hits in the second half of the year—Anshul is confirming, I think we can have a multi-year success in routing in 2020 and beyond with Jericho 2.

And I'm just kind of curious, how much opportunity do you see that total addressable router market today and how much do you think is that going to expand?

It's a tough one to answer. The total market is $8 billion, but I think our TAM is more like two to three—it's a good guess. But some of them end up being very specific, traditional legacy MPLS traffic engineering boxes - Arista doesn't play in that. But as they look to come in, as Manny was describing into the spine, peering and interconnect and NFV and Telco cloud, Arista is a national player to combine the universal spine switching and routing.

Right, thank you.

Thank you, Aaron.

Great, thanks for taking the question. I wanted to see if we could, maybe take a look at getting some thoughts on 2020 in particular, if I characterize your base business as put to side and thinking about three growth engines - campus switching, routing, and 400-gig switching as the incremental part, how do you see those three in terms of rank order contributors in 2020? Thank you.

Wow, you get the prize for the tough question so far, right up there with Paul.

I'm honored.

We'll give it our best but this is purely a forecast. I think if you look at TAM, the largest TAM of these three - campus, routing, and 400-gig is campus. And it's also the most underserved by any alternative competitor, because it's so deeply embedded by incumbency. So we believe our largest strength and opportunity is campus and our largest pressure to execute is also campus, if I put that in that way. And then I think if I had to split the two, I would say routing second than 400-gig third, because I think routing really doesn't come in - 400-gig doesn't really come into play in a huge way until 2020.

That's very much what I was looking for, thank you.

Thank you, Simon.

Hey, this is Michael Berg going for Erik Suppiger. Congrats on a great print. I just wanted a quick question on international; could you pull any color around what may have caused the weakness there? I mean was it around international cloud spending or enterprise spending, what do you think your own international in the quarter.

Yeah, I mean you know the mix between international and U.S. in any given quarter is going to be pretty volatile, right. If you look at it for the year, which I think is kind of more interesting and you peel it back, you've got good growth in the in-region businesses and then just a heavier deployment of cloud in the U.S. than what we saw last year. We had seen some pretty heavy international cloud activity last year, this year it's been more U.S. focused, right so I think that's probably the biggest driver. If I strip all that out and look at the growth in the region, those businesses are going faster than the corporate average. I think Manny, if you want to chime in as well.

Yeah, I think what I'll add on top of that and I think Jayshree said it and Ita said as well, is we are actually seeing great and we're making a significant investment in our international markets from a headcount perspective. We're bouncing that out fairly nicely; approximately 40% is going to international headcount, that's a little higher than what you're seeing from a percentage of business. But what's more interesting is the net new logos where we are seeing a lot of new wins there; approximately half of our net new logos are coming out of the international market so having great traction there, great acceptance of technology. You could argue in some of the international markets they're a little behind in the adoption of spine leaf architectures, but they're coming along quite nicely, and we think that's a growth engine also for the future.

Okay, great. And then a quick follow-up on the Microsoft piece, I know you mentioned that if you normalize it, it's closer to the 16%, but if I'm thinking about the deferred revenue piece being a big contributor wouldn't that leave it to be closer to 18-20% percent? How can I think about how deferred contributed to Microsoft in the year?

Yeah, I don’t think we're going to do that, right. It moved around. Yeah, it's not really helpful to start to try and do that on a quarterly basis. I think the annual number is really the way to think about it and then take some off the top for the deferred, for the release of the legal related certification stuff at the beginning of last year. And so think about 16% was our norm, for the last couple of years. I think it was a good strong year for Microsoft on top of that just from a transactional business perspective.

Okay. And then I think someone asked this before, but is it fair to assume that the cloud titans vertical was closer to 40% or even higher percentage of total revenue for the year, given the high Microsoft contribution?

I think around there is a fair guess.

Okay, awesome. Well, hey, congrats on a great quarter again and thank you for the time.

Thank you, Erik.

Great. Thank you very much. Could you comment a bit about expenses going forward? You had a year-over-year acceleration in marketing, a deceleration in R&D, which you talked about a little bit. What sorts of growth rates or percentages of revenue can we look forward to? And your longer term target of 32% operating margin, what's the timeframe for that? Is it going to be within my lifetime?

Yeah, it depends how long you live. Yeah, surely it's been a while since you updated the…

I'm getting up there.

It's a long-term model and we'll take the opportunity to do that at some point here. I mean, I think what we're seeing is in the near-term timeframe, the plus or minus 35% operating margin is a good way to think about it. And that allows us to see some movement of gross margin quarter-over-quarter and make the investments that we want to make. Right, I mean, if we're—yeah, we're still in a situation where we're growing the top line at the rate that we're growing the top line at. It's letting us to and make the investments that we need to make. It's that Manny do what he needs to do in the sales and marketing side. And I think you will see that kind of be maybe more of a percentage of revenue than it has been. And maybe we get a little bit of leverage on the R&D, but that's not going to be the same every quarter and it's not significant, right. And I think about the 35% plus or minus.

Thank you for taking my question, and congrats, Anshul, congrats on the great quarter as well. Just one clarification maybe for Ita. Would it be possible to give us what Microsoft was in Q4 or even second half versus first half as a percent of sales?

Yeah, I don't think we're going to do that, right. It moved around. Yeah, it's not really helpful to start to try and do that on a quarterly basis. I think the annual number is really the way to think about it and then take some off the top for the deferred, for the release of the legal related certification stuff at the beginning of last year. And so think about 16% was our norm, for the last couple years. I think it was a good strong year for Microsoft on top of that just from a transactional business perspective.