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Arista Networks, Inc. (NYSE:ANET)
Q2 2018 Earnings Conference Call
August 2nd, 2018, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to the second quarter 2018 Arista Networks financial results earnings conference call. During the call, all participants will be in a listen-only mode. After the presentation, we will conduct a question and answer session. Instructions will be provided at that time. If at any time during the conference you need to reach an operator, please press the * followed by 0. As a reminder, this conference is being recorded and will be available for replay from the Investor Relations section at the Arista website following this call.

I will now turn to the call over to Mr. Chuck Elliott, Director of Business and Investor Development. Sir, you may begin.

Chuck Elliott -- Director of Business and Investor Development 

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 fiscal second quarter 2018. If you would like a copy of the release, you can access it online at the company's website.

During the course of this conference call, Arista Networks' management will make forward-looking statements, including those relating to our financial outlook for the third quarter of the 2018 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-Q and Forum 10-K and which could cause actual results to differ materially from those anticipated by these statements.

These forward-looking statements apply as of today and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call.

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 reconciliation for these non-GAAP financial measures to GAAP financial measures in our earnings press release.

With that, I will turn the call over to Jayshree.

Jayshree Ullal -- President and Chief Executive Officer

Thank you, Chuck. Thank you, everyone for joining us this afternoon for our second quarter of 2018 earnings call. I am pleased to report that we had a record Q2, surpassing the $500 million mark. We exceeded our guidance comfortably with a non-GAAP revenue of $519.8 million as we grew more than 28% year over year, despite tough comparisons from 2017.

Our non-GAAP earnings per share was $1.93 with services contribution at 14.4% of overall sales. From a geographic perspective, our customers in the Americas contributed 73% of our total revenue, while the rest of the international theaters performed reasonably well. We delivered non-GAAP gross margins of 64.5% in our dynamic industry, exceeding our forecast due to customer mix.

In terms of vertical trends, our top ten customers included all five verticals. Cloud Titans contributed strongly in Q2 and ranked as our number one vertical, followed by enterprises and cloud specialized providers at number two, and financials and tier one/tier two service providers tied for third place.

Our new customer acquisition continues to be brisk and our million-dollar customers continue to be healthy as well. We're especially pleased with the software and services acceptance with CloudVision customers. In terms of new introductions in Q2, we had an analyst day on May 7th, 2018. Arista introduced our formal entry into the campus markets with our products and the cognitive management plane architecture.

So, you might be thinking why did we enter this market. The simple fact is our customers have been asking us to do so for some time. They have been deploying Arista products and campus use cases already to take advantage of Arista EOS quality and our state-driven software architecture. Overcoming the legacy three-tiered model from the market incumbents, the Arista X3 spline is another example of disrupting the status quo.

We are collapsing the aggregation and co-layers into a single tier. Chassis and fixed form factors are now available in Q3 2018 with wire speed layer 2, layer 3 switching rate and a cognitive suite of campus controls, such as high resilience, secure segmentation, and scale options for different range of protocols for L2, L3, and L2 over L3.

The Arista Cognitive Campus also works with a diverse suite of edge devices, including third-party. Today, Arista is also announcing its first acquisition, Mojo Networks, to expand into the cognitive Wi-Fi edge. We believe that cloud-managed cognitive Wi-Fi is a very natural complement to our next generation campus and cloud networking portfolio.

I want to take this opportunity to warmly welcome Rick Wilmer, the CEO of Mojo Networks, and Pravin Bhagwat, Founder and CTO of Mojo, as well as the entire Mojo team to the Arista family. This transaction will close in Q3 2018 and I expect this to be accretive in 2019.

At the core of our campus strategy is our powerful cognitive management architecture, whereby the network auto-discovers connected devices, applications, and streaming data. CMP based on CloudVision assesses profile-based parameters such as configlets, bandwidth, packet size, inner-packet gap, open ports, whitelists, etc.

I could go on and on, but I would like to invite our chief guest, the Chief Technology Officer of Arista, Ken Duda, and our Senior VP of Software Engineering, to say a few words. Ken?

Kenneth Duda -- Chief Technology Officer and Senior Vice President of Software Engineering

Thanks, Jayshree. With the CloudVision cognitive management plane, Arista is fundamentally advancing the way networks are operated and managed. CloudVision gathers all network states to a single place, keeping historical information as long as the customer wants it and analyzing and learning from all of that state.

Operators enforce networkwide policy centrally and CloudVision autonomously ensures that policy is implemented correctly across the entire network, flagging any compliance issues and creating workflows applied on approval to bring devices back into full compliance.

What sets CloudVision apart is the confidence that it brings, confidence that things are working and working the way you'd expect. So, you can now imagine how delighted we were to integrate Mojo Networks technology. Mojo pioneered cognitive Wi-Fi, in which Wi-Fi states streams from access points to a centralized open source data store for analysis.

By itself, it's a big help for network operators, helping with capacity planning, upgrades, troubleshooting performance issues, but in combination with CloudVision, it's even better. We can now extend CloudVision's reach enterprisewide, from the Wi-Fi client across the campus to the enterprise data center and all the way to the cloud.

This gives CloudVision customers a single pane of glass through which they can see everything going on end to end through their network. They can use one assistant that both ensures security compliance for physical switches, and also generates alerts about Wi-Fi connection issues. They can apply the same security policies to the network edge, whether that edge is wired, wireless, or virtual. They can monitor for unauthorized or misbehaving IoT devices, again, wherever and however connected.

But at a higher level, our campus strategy is very simple. We're bringing the benefits of Arista's data center switches to the enterprise campus. These benefits are high-quality, trouble-free devices. A single software image across all switches for consistency and simplicity of operations and cognitive management, lowering operational costs through automation and providing advanced compliance, visibility, and telemetry features.

Jayshree Ullal -- President and Chief Executive Officer

Thank you, Ken. Your passion and enthusiasm on technology is always infectious. So, I want to get that CMP right now and install it at home. We are witnessing an architectural shift in the campus that's really similar to the data center migration. When you look at what we're doing, it's an important step to what's taking these silo places in the network, or pins of yesteryear, to the cloud-first strategy with PICs, or places in the cloud, as an important evolution to our customers.

During this time, we remain committed to our HPE/Aruba partnership for mutual customers and to also promote open and multi-vendor interoperability. In Q2, we also introduced an exciting programmable product, the Arista 7170. The new 7170 series is bringing a new generation of programmable packet processors for 64 ports of 100 GB Ethernet all in a single, fixed leaf form factor, using a new merchant silicon vendor, Barefoot Networks, to make this possible.

Traditionally, building such a chip that was both programmable and extremely fast wasn't so doable without trade-offs, but with the Arista 7170, this defies tradition. It's integrating a suite of capabilities that previously ran on a host or VM or NIC into a single one-rack unit switch. Examples of this programmability include advanced layer 4 to layer 7 features, tunnel termination, traffic filtering, network address translation, and deeper packet inspection.

The 7170 embodies Arista's EOS cognitive features at scale with modern P4 language. Use cases include tunnel scaling in multi-tenant data center, applying network security segmentation, real time network telemetry, timestamping, visibility, and packet capture.

As I took at our progress in Q2 2018 and in fact step back and reflect on the first half of 2018, I'm pleased by our progress on many fronts, as we have moved from point products to software-driven cloud platforms with best of breed capabilities. We are gratified by the continued recognition from Gartner as a leader in their Magic Quadrant for data center networking for the fourth consecutive year, as well Forrester's SDN Wave leader in the hardware category with the top score.

Arista was also recognized by Forbes as a Global 2000 company for the first time in June 2018. Clearly, we're one of the fastest growing networking companies in recent history, achieving $2 billion in annual revenue run rate with profitability metrics. I'm definitely excited by our future ahead.

With that, I'd like to turn it over to Ita, our Chief Financial Officer, for more financial specifics. Ita?

Ita Brennan -- Chief Financial Officer

Thanks, Jayshree, and good afternoon. This analysis of our Q2 results and our guidance for Q3 '18 is based on non-GAAP and excludes all non-cash stock-based compensation impacts and impairment of our private company equity investments and legal costs associated with the ongoing lawsuits. A full reconciliation of our selected GAAP to non-GAAP results is provided in our earnings release.

Total revenues in Q2 were $519.8 million, up 28% year over year and above our guidance of $500 million to $514 million. We were pleased with overall demand in the quarter, with ongoing strengths from our productizing vertical. Service revenues for the quarter were approximately 14.4% of revenue, up from prior periods and reflecting higher renewal activity.

International revenue for the quarter came in at $142 million or 27% of total revenue, down from 33% in the prior period. The lower international mix on a quarter over quarter basis primarily reflecting the timing of some cloud deployments and the inclusion of some larger in-region EMEA deals last quarter.

Our international base is still relatively small and we'll experience some volatility on a quarterly basis as the business develops. Overall gross margins in Q2 are 64.5%, up from 64.4% last quarter and above the midpoint of our guidance, up 62% to 64%. This outperformance versus guidance primarily reflected increased leverage on our fixed cost base in the quarter.

Operating expenses for the quarter were $143.9 million, up from $137.4 million last quarter. R&D spending came in at $92.3 million or 17.8% of revenue, up from $91.4 million in the prior period with increased headcount and related expenses. Sales and marketing expense was $39.9 million or 7.7% of revenue, up from $36.2 million last quarter, reflecting increased marketing and demo-related expenses. Our GAA costs included some legal and accounting fees associated with Mojo acquisition announced today.

Our operating income for the quarter was $191.2 million, or 36.8% of revenue. Other income and expense for the quarter was a favorable $6.9 million and our effective tax rate was 21.4%. This resulted in net income for the quarter of $155.7 million or 30% of revenue. Our diluted share number for the quarter was 80.8 million shares, resulting in a diluted earnings per share number of $1.93, up 44% from the prior year.

Legal expenses associated with the ongoing lawsuits came in at $3.6 million for the quarter. In addition, we recorded a $9.1 million impairment of our private company equity investments, projecting evaluation adjustments based on a recent funding lapse. Both of theses amounts are excluded from the non-GAAP results discussed above.

Now turning to the balance sheet, cash-cash equivalents and investments entered the quarter at approximately $1.9 billion. We generated $130.6 million of cash from operations in the June quarter. This reflects strong net income performance offset by changes in working capital requirements. DSOs came at 46 days, up from 39 in Q1, reflecting the timing of billings and collections in the quarter.

Inventory terms were 2.7 times, up from 2.2 in Q1 and inventory decreased to 245.4 million in the quarter, down from 268.1 million in the prior period. This reflects reductions primarily in finished goods as we continued to optimize our supply chain. In addition, we maintain the further 25.3 million of inventory deposits recorded in other assets compared to 24 million last quarter.

Our total deferred revenue balance was $448.6 million, down from $456.1 million in Q1. Product-deferred revenue declined by $15 million in the quarter, with customers completing final 945-related qualifications. At this point, we believed we've reached a somewhat normalized level of product-deferred revenue. While the underlying transactions will cycle on a quarter by quarter basis, the magnitude of the balance should stabilize. Accounts payable days were 26 days, down from 38 days in Q1, reflecting the timing of inventory receipts and payments. Capital expenditures in the quarter were $6.7 million.

Now turning to guidance -- as we look forward to the remainder of 2018, we believe that we are well-positioned to benefit from the continuing growth in cloud networking across our customer base. Our revenue guidance for the third quarter is consistent with our previous outlook, which calls for mid-20% revenue growth for the second half of the year.

The operations team is currently working to understand and attempt to mitigate any potential gross margin headwind related to the trade tariff announcement. We would ultimately look to pass on any un-remediated costs to customers.

We announced earlier today that we are acquiring Mojo Networks. This represents a small but strategic transaction which we expect to play an important role in our overall expansion into campus. We are just beginning the business and accounting integration and the acquisition will be recorded in our financials for the third quarter.

With this as a backdrop, our guidance for the third quarter, which is based on non-GAAP and excludes any non-cash stock-based compensation impacts and any legal costs associated with the ongoing lawsuits is as follows -- revenues of approximately $540 million to $552 million, gross margin of approximately 63% to 65%, operating margins of approximately 32% to 34%.

Our effective tax rate is expected to be approximately 21.5% with diluted shares of approximately 81.1 million. Please note that based on our current outlook, expect costs associated with ongoing to lawsuits to be approximately $6 million for the quarter.

I will now turn the call back to Chuck. Chuck?

Chuck Elliott -- Director of Business and Investor Development 

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

Questions and Answers:

Operator

We will now begin the Q&A portion of the Arista earnings call. In order to ask a question during this time, simply press * then the number 1 on your telephone keypad. If you'd like to withdraw your question, press the # key. We ask that you pick up your handset before asking questions in order to ensure optimal sound quality.

Your first question comes from James Fish with Piper Jaffray. Your line is open.

James Fish -- Piper Jaffray -- Analyst

Hey, congrats on the quarter here and congrats on the deal as well with Mojo Networks. I'll just keep it to one question as requested. I guess maybe just to start off, can we talk about what you're seeing in terms of traction in the campus and where we are with the enterprise investments and sales buildout for the campus? Thank you.

Jayshree Ullal -- President and Chief Executive Officer

Thank you, James. As you know if you were here in May, we announced the vision and we said products would really be in the second half. As you rightly point out, a lot of the interest in the campus is directly tied to enterprise customers. Many enterprise customers have already been using us in the data center with our EOS and want to have a common spline architecture for both the campus edge and the data center edge.

So, those products are rolling out in Q3. So, we're in very early sampling with customers. I don't expect material engagement with them in this second half, but I expect a lot of customer interest. Really, the material impact of that will be next year. So far, it's very promising. There's a lot of interest.

There's a lot of also commonality and protocols because the work we're doing with VXLAN, EVPN, PGP protocols, plain old-fashioned VLAN with MLAG looking back in what we did in the early years are all applicable in the campus. We're also working closely with HPE and their PoE switches and the Aruba wireless as well to make sure they work with our spline.

James Fish -- Piper Jaffray -- Analyst

And on the investment side of that?

Jayshree Ullal -- President and Chief Executive Officer

What was the question?

James Fish -- Piper Jaffray -- Analyst

How far along are we?

Jayshree Ullal -- President and Chief Executive Officer

Yeah. We're just starting. Manny Rivelo is driving a lot of this investment. It's part of our sales and marketing investment in general in expanding both to channels and putting more presence in the enterprise. I would say every region is making a strong investment there and we've already started that activity since May.

James Fish -- Piper Jaffray -- Analyst

Got it. Thank you.

Operator

Your next question comes from James Faucette with Morgan Stanley. Your line is open.

James Faucette -- Morgan Stanley -- Analyst

Thanks. I will also keep my question to one, mainly because Chuck said please. Jayshree, I'm wondering if you can comment just on the general macro environment. We have a lot of conversations with investors about what the demand picture particularly from hyperscale looks like and what the competitive environment is, if there are changes there from existing competition or from white box. So, I'd just like to hear how you're viewing both the demand and competitive sides of the market, particularly for hyperscale customers.

Jayshree Ullal -- President and Chief Executive Officer

Thank you, James. Is James the popular name today for questions? So, macroenvironment for Cloud Titans or cloud hyperscale in general is good and healthy. They continue to be our number one vertical, both in Q1/Q2 and I anticipate that's going to be the same in the second half with the certifications, the worst of it behind us. And with much of the cloud spend available, it's always competitive. It's always dynamic, but I think Arista is strongly considered and continues to be considered an important partner and vendor for the Cloud Titans.

So, I have not seen any appreciable change in the competitive landscape. I think we have strong spending that can we expect from them throughout this year. The white box is a white box, meaning some of them captive implementations in their own sites and have had it even before Arista was founded. We continue to work with them in several tiers, but nothing new there as well.

James Faucette -- Morgan Stanley -- Analyst

Thank you.

Jayshree Ullal -- President and Chief Executive Officer

Thank you, James.

Operator

Your next question comes from Samik Chatterjee with J.P. Morgan. Your line is open.

Samik Chatterjee -- J.P. Morgan -- Analyst

Hi. Thanks for taking my question. I just wanted to ask on the acquisition can you share some details on Mojo Networks and their pipeline of customers they're already working with and what is your expectation in terms of revenue synergies from this transaction?

Jayshree Ullal -- President and Chief Executive Officer

I'll give it my best shot. It's very early days. What fascinated us about Mojo is as you know, we believe the cognitive edge for the campus is changing significantly. In the past, Wi-Fi was always a second-class citizen to wired. You never talked about performance of Wi-Fi in gigabytes. It was always megabytes or very slow speed.

What we're seeing now with 802.1AX and performance in general is Wi-Fi is approaching multi-gigabyte speed just like wired is. So, the synergy for us is to really focus on making Mojo a software-based acquisition where we care less about the access point and we care more about the cognitive controls, the integration into cloud vision and CMP architecture and the importance of bringing all of these cognitive controls not just to this client but to the Wi-Fi edge.

The company has been around a long time. They have a deep expertise in not only Wi-Fi, but also on security with their wireless intrusion protection services. Ken, you were with us in the room and you spent a fair amount of time on the due diligence. If you want to add a few words to that, what do you think the promise of Mojo is?

Kenneth Duda -- Chief Technology Officer and Senior Vice President of Software Engineering

We just felt very good alignment with the Mojo team from a technical architecture point of view. The state management approach that we pioneered in EOS, they've done something similar on the Wi-Fi management side. So, we just felt like it's going to be really exciting to make our products work together as a seamless group.

Samik Chatterjee -- J.P. Morgan -- Analyst

Thank you.

Jayshree Ullal -- President and Chief Executive Officer

Thank you, Samik.

Operator

Your next question comes from Sami Badri with Credit Suisse. Your line is open.

Sami Badri -- Credit Suisse -- Analyst

Thank you. My question has more to do with operating margins. I know given the campus switching opportunity, you will be scaling the channel or giving an opportunity. Do we expect operating margin on the corporate level to converge down to where you guided to it on your analyst day, more on the 32% to 34% range? I just want to get some perspective on that and the plan as far as sales and marketing spend, given you just came in above 36%.

Ita Brennan -- Chief Financial Officer

Yeah. I think we still revert back to over the long-term, we see the model as being the 32% to 34%. Within that, we've talked about the different levels of investment with sales and marketing being in the 10% range. That doesn't happen overnight. We have to grow into it. It is going to take time. Obviously, it depends on what the top line is doing at the same time. I think that's still the longer-term model is that it would be a 10% plus or minus sales and marketing investment. We think with that, just given the different price of the business that that can support an adequate investment from a sales and marketing perspective in the enterprise/campus part of the business.

Jayshree Ullal -- President and Chief Executive Officer

And you may recall Ita shared this at analyst day, that in the sales and marketing, we expect the enterprise and international to be higher than the averages. We expect the cloud to be lower than the averages because it's a very technology-driven support and sales model. Obviously, there will be moving parts on different verticals there.

Sami Badri -- Credit Suisse -- Analyst

Got it. Just one follow-up related to one of your peers noting that cloud deals got pushed out -- is Arista Networks seeing a very similar dynamic with key customers?

Jayshree Ullal -- President and Chief Executive Officer

No.

Sami Badri -- Credit Suisse -- Analyst

Got it. Thank you.

Operator

Your next question comes from Simon Leopold with Raymond James. Your line is open.

Simon Leopold -- Raymond James -- Analyst

Thank you for taking my question. On the last call and at the analyst meeting, Andy had made some comments about, I guess, an inflection point in 100 GB. I'm wondering if we could get a little bit more color on your trends in terms of 100 GB ports, whether you're seeing some kind of inflection point and whether this helps your overall ASPs grow and whether this is an element helping your overall cloud business.

Jayshree Ullal -- President and Chief Executive Officer

Okay. Thanks, Simon. I think it's safe to say Arista has really emerged in the last year as a market leader in 100 GB. When you look at all the ports we are driving and the associated ASPs, most market analysts would have us at from 35% to 40%+ in market share. So, we are the number one in 100 GB and have been for the entire 2017. We haven't seen that change in 2018. I think the reasons for that are many.

Andy is absolutely correct. 100 GB ends up being that common denominator of spline aggregation that's just perfect for many use cases. It can be a value server aggregation. It can be storage. It can be campus. It can be security. We see that I guess when you say inflection point, we see a continued inflection point for the next several years.

That's probably the way I would say it. That is just inflecting for quite a while here. And as 400 GB comes in in 2019 and 2020, 100 GB continues to be vibrant. So, we see the two working in tandem in the later years, but currently, 100 GB is very, very strong.

Simon Leopold -- Raymond James -- Analyst

Are there metrics you can share in terms of percent of sale or percent of ports, something to help us understand that?

Jayshree Ullal -- President and Chief Executive Officer

It depends on the vertical, but to give you a general sense, in the cloud vertical, 100 GB is extremely important. I can't think of a single cloud use case where we don't discuss, implement, or deploy 100 GB in the leaf or spline.

In the enterprise, it can vary. 10 GB can be very important then and they may sometimes look at 40 GB. But they're quickly starting to see the early adopters of enterprise also embrace 100 GB. But that's where it can vary a little bit. The other big thing we're seeing is you can see quite an excitement in the cloud environment on modular 100 GB, which is stronger with particularly the large-scale cloud operators baselining on a large amount of ports.

So, the scale of 100 GB is far greater. But at the same time, when you go into some of the tier 1, tier 2 service providers, we're seeing a lot of 100 GB in the data center or in the residential homes as well. So, I guess the net of this is we see that high-performance, 10, 25, 40, 100 GB is very much a strong suite with a much stronger position in 100 GB itself.

Simon Leopold -- Raymond James -- Analyst

Thank you.

Operator

Your next question comes from Alex Henderson with Needham. Your line is open.

Alex Henderson -- Needham & Company -- Managing Director

Thanks. I'm hoping you will give us a little more granularity on the acquisitions contributions, given the fact that it's going to close, according to the press release in the third quarter. What is included or not included in the guidance for it? The other data point I was looking for was the aggregate enterprise business, if you aggregate all of the various enterprise verticals, what was the growth rate in enterprise year over year in the quarter just reported? Thanks.

Ita Brennan -- Chief Financial Officer

I don't know the we're going to give the exact growth rate quarter of quarter, but it was healthy. Enterprise was tied for the number two slot in our verticals and it continues to grow healthily. I think when you think about the acquisition and incorporating into the numbers, this is a software model. It's a routable model. So, it's going to, particularly as we work through some of the purchase accounting, etc., it's going to have not a very significant impact on the numbers in Q3.

So, I think for now, you can take the guidance as is and expect it not to change just because of the acquisition. Going forward, obviously, it will be a contributor to our software routable revenue stream in the future, but I think for Q3 and the guidance, you should take the guidance as is.

Alex Henderson -- Needham & Company -- Managing Director

What about on the cost side of the equation for that?

Ita Brennan -- Chief Financial Officer

I'd be inclined to say it's something similar. We will have the cost there. It's effectively less in the quarter. It won't be there in the whole quarter. It will be easily absorbed into the guidance that we gave you already.

Alex Henderson -- Needham & Company -- Managing Director

Okay. Thank you.

Operator

Your next comes from Jason Ader with William Blair. Your line is open.

Jason Ader -- William Blair & Company -- Analyst

Thanks. Hi, guys. Your campus strategy, how should we think about the wiring closet? The Mojo acquisition obviously shows that you felt that you needed wireless to bolster your campus offering. Should we expect to see wiring closet switches from Arista, ultimately?

Jayshree Ullal -- President and Chief Executive Officer

I think that we're approaching the campus, Jason, in a very steady, systematic manner, similar to the way we did the data center. So, we're not married to the entire campus portfolio coming from Arista. HPE is a good partner for us. So, our first approach will be the cognitive management plane and spline. Our phase two approach will be in wireless endpoints or edges that require that. Depending on how we do it, we don't rule out the possibility of entering deeper in the market. We're not making any roadmap suggestions or announcements here.

Jason Ader -- William Blair & Company -- Analyst

How did Aruba respond to this?

Jayshree Ullal -- President and Chief Executive Officer

We've had a three, four-year partnership. This is a very professional partnership and there's also a deep friendship. This partnership is well-beyond the Mojo acquisition. We're working very closely in the data center. We will continue to work together on the campus as well. They understand our strategy and we understand theirs and we work together. 90% of it is complementary.

Operator

Your next question comes from Aaron Rakers with Wells Fargo. Your line is open.

Aaron Rakers -- Wells Fargo -- Managing Director

Yeah. Thank you for taking the question. One of the things I didn't hear a lot of on this call at this point has been your router business. I'm just curious if you have any updates as it relates to the traction in the router market. In particular, how should we think about the next phase, if you will, of expansion of opportunities in that router market. Is that tied to things like Jericho2 silicon or are there other things we can look at over next 12 months or so to say Arista is expanding further?

Jayshree Ullal -- President and Chief Executive Officer

Thanks, Aaron. I should have said a little bit more. We are very proud of our focus on routing. As you know, we don't need to wait for Jericho2. Arista is already making great inroads with the FlexRoute licenses that we have and it has grown steadily quarter over quarter. You might know that we ended the year last year reporting that we were over 200 FlexRoute licenses.

Rather than reporting it quarter over quarter since it's no more new, I told you guys I'd come back to you year over year, I fully expect we will double that and I fully expect we will see new customers like we do every quarter. The customers come in a variety of categories. They come in terms of new use cases in the cloud to new enterprises to, of course, tier 1 and tier 2 service provider.

If there's an area I would challenge myself and the team to do better, it's probably the service providers. They take a little longer and it's definitely tested Arista's patience. I think technologically, we're doing very, very well with them, but operationally, it takes longer to test and deploy.

Aaron Rakers -- Wells Fargo -- Managing Director

Thank you.

Jayshree Ullal -- President and Chief Executive Officer

Thank you, Aaron.

Operator

Your next question comes from Jim Suva with Citi. Your line is open.

Jim Suva -- Citigroup -- Analyst

Thank you so much for the details so far. Just one question from me -- if I heard the prepared comments correctly, it was no change to the 2018 outlook, but I'm just trying to bridge the different pieces here. You just beat in a very impressive way. Organically, you're very deep and you added on an acquisition that's going to close in Q3, but you mentioned no change to Q3 or 2018. So, are you seeing some softness in your order book going forward? Your deferred revenues came down some and you're saying no change, yet you have an acquisition because you just beat. So, I'm just trying to put those pieces together. Thank you so much.

Ita Brennan -- Chief Financial Officer

I think, Jim, if you look at what we did, we grew 28% in Q2. We guided 26% at the upper end of the range and then we'll see what we do from there. The acquisition, like I said, it is a software model, so it will be a routable model. So, we need to work through some of that. It's not likely to be a big driver of topline just because we'll have to do some of the purchase accounting on their deferred and it will be a routable model from there on. We're still consistent to our mid-20s from the back-half of the year.

The up-end of the guidance, the up-end of the range is a 26% growth rate and then we'll see what we do from there. I don't think we've seen any particular softness in the business. You would have heard my comments on deferred revenue. I think deferred revenue stabilized now. So, the Q3 guide should not benefit from deferred or from a decline in product deferred. It should stand on its own. I think we're pretty happy with that as a guidance case and then we'll go from there.

Jim Suva -- Citigroup -- Analyst

Great. Thank you so much for your details. Much appreciated.

Operator

Your next question comes from Alex Kurtz with KeyBanc. Your line is open.

Steve Enders -- KeyBanc Capital Markets -- Analyst

Hi, this is Steve Enders on for Alex. Thanks for taking my question. I was wondering if you could characterize the trends you're seeing in Cloud Titan spend at this point. Is it more coming from new data center buildouts or is it more about expansion of existing footprint?

Jayshree Ullal -- President and Chief Executive Officer

Steve, it's always a combination of both. As you know, a majority of our Cloud Titan customers are not just incrementally growing. They're always constructing new data centers, but they also have to go back in existing data centers and incrementally add. We're seeing a nice combination of both. I wouldn't put weight on one versus the other. Both sides are doing well.

Steve Enders -- KeyBanc Capital Markets -- Analyst

Has there been any change in the mix there over the past year?

Jayshree Ullal -- President and Chief Executive Officer

I think because of the 100 GB onset, the biggest change to the mix is there's more 100 GB in both examples. Beyond that, no big change.

Steve Enders -- KeyBanc Capital Markets -- Analyst

Great. Thank you.

Jayshree Ullal -- President and Chief Executive Officer

Thank you, Steve.

Operator

Your next question comes from Paul Silverstein with Cowen. Your line is open.

Paul Silverstein -- Cowen & Company -- Managing Director

I'm sure you're going to love me after these questions. First off...

Jayshree Ullal -- President and Chief Executive Officer

Just one question, Paul, right?

Paul Silverstein -- Cowen & Company -- Managing Director

Well, I'm a little slow on the uptake, so I'm hoping you'll just clarify some things for me. On Simon's question about Mojo revenue and the third-quarter guidance, you're seeing that guidance does include or does not include any revenue from Mojo?

Ita Brennan -- Chief Financial Officer

It's going to get incorporated sometime mid-Q3 and it's a routable software model. It's not going to move the needle is what we're really saying.

Jayshree Ullal -- President and Chief Executive Officer

We're saying it's a small acquisition and the revenue is small. Whether it does or doesn't is well within the error of our guidance.

Paul Silverstein -- Cowen & Company -- Managing Director

Got it. Alright. And on the calendar '18 revenue guidance, you're saying you're expecting mid-20s for the back-half of the year as opposed to mid-20s for the whole year.

Ita Brennan -- Chief Financial Officer

Correct.

Paul Silverstein -- Cowen & Company -- Managing Director

Alright. Now for the real questions -- pricing, any change one way or the other?

Jayshree Ullal -- President and Chief Executive Officer

Paul, I've said this before -- no dramatic change. Same aggressive, competitive situation we've always seen. So, it's no different than last quarter.

Paul Silverstein -- Cowen & Company -- Managing Director

Alright. Now that I've got those clarifications out of the way, I appreciate that.

Jayshree Ullal -- President and Chief Executive Officer

Next question?

Paul Silverstein -- Cowen & Company -- Managing Director

My final question -- with respect to...

Chuck Elliott -- Director of Business and Investor Development 

Hold it for a call back, please.

Paul Silverstein -- Cowen & Company -- Managing Director

No worries.

Jayshree Ullal -- President and Chief Executive Officer

Thanks, Paul.

Operator

Your next question comes from Mitch Steves with RBC Capital Markets. Your line is open.

Mitch Steves -- RBC Capital Markets -- Analyst

Hey, guys. Thanks for taking my questions. I just have one, actually. It says that Mojo Networks is supposed to get to about $100 million run rate in about two years and this article is dated in January of '18. My question is is there any reason why you wouldn't be able to exceed that expectation due to being integrated with Arista, i.e. are there any sale synergies with Mojo Networks and Arista working together?

Jayshree Ullal -- President and Chief Executive Officer

Oh, boy. That sounds like an ambitious goal from their current revenue. I have to speak to Rick about my forecasting talents versus his. How about we come back to you on that one after we know better on integration? That sounds like a very high number.

Mitch Steves -- RBC Capital Markets -- Analyst

Okay. Got it.

Jayshree Ullal -- President and Chief Executive Officer

Thanks, Mitch. I owe you an answer.

Operator

Your next question comes from Rod Hall with Goldman Sachs. Your line is open.

Rod Hall -- Goldman Sachs -- Managing Director

Hi, thanks for the question. I just wanted to come back to -- we've had a lot of incoming questions from investors about inventories at your large cloud customers. There's a theory floating around that maybe they have some inventory as a result of the patent cases that they're unwinding and that's having an effect on sales maybe in the short-term. I wonder if you can comment on that and even the fact that even at the 25% growth rate in the second half, your seasonality has shifted pretty significantly toward the first half of the year, more so than normal. Normally, we'd see a bit more revenue in the back-half of the year. I'm just curious if you could squeeze those two things together for me.

Ita Brennan -- Chief Financial Officer

Yeah, just the revenue trend, let's take that first -- obviously, Q1, we grew 40+% year over year because that was a much easier comp off of the first quarter last year. I don't think there's anything necessarily different in seasonality that we're calling out at this point. So, we're saying mid-20s for the back-half of the year, like I said, 26% is the upper end of the range for Q3 and we'll see where we go from there.

Jayshree Ullal -- President and Chief Executive Officer

So, just to reiterate what Ita said, Rod, we're feeling very good about cloud spending. We have in Q1. We definitely do in the Q2 results. The second half is looking strong. So, when you say they have some inventory, there's always this issue of did they order the right mix. We don't see that as a category...

Rod Hall -- Goldman Sachs -- Managing Director

I'm not saying they have inventory. I'm just really asking you if you think they have inventory.

Jayshree Ullal -- President and Chief Executive Officer

I would say, Rod, that speculation is probably not what we're seeing. We're seeing healthy demand and if they had an inventory, they probably wouldn't be buying more. So, from our perspective, the cloud, which was kind of in a hiccup for us when we were going through certifications in last Q3/Q4 is back and it's back strongly.

Rod Hall -- Goldman Sachs -- Managing Director

Great. Helpful. Thank you.

Jayshree Ullal -- President and Chief Executive Officer

Thank you.

Operator

Your next question comes from Jeff Kvaal with Nomura Instinet. Your line is open.

Jeff Kvaal -- Nomura Instinet -- Managing Director

Thank you all very much. Last year, the 100 GB transition obviously was very favorable for you all. We've got another tech transition happening in about year with 400 in 2019. Can you talk about your positioning for 400 and maybe perhaps your relative positioning versus the competition? With the 100, you were so far out front that you gained a lot of share. Should we think that your competitive lead there has stayed the same and there's more share to take or is this more of a sedate share gain situation? Thanks.

Jayshree Ullal -- President and Chief Executive Officer

Thank you, Jeff. If you would ask me to predict whether we would have a sedate share gain in 100 GB, I would have thought perhaps that would be the case. So, we were pleasantly surprised to see the dramatic market share gains in 100 GB. I would attribute that to two reasons -- one, Ken and the team building excellent products and the other, our competition did not respond to 100 GB as well as we did.

Now, let's switch gears to your 400 GB question -- my view, as I said quite often, is the 100 GB inflection is a multi-year inflection. We're going to continue to see strength. This is going to be in the form of higher density, in the form of additional options and form factors, in the form of 200 GB options. So, I don't think the onset of 400 GB in any way changes the momentum on 100 GB. This is really important to remember. This is going to be the largest market.

Now, as the market leader in 100 GB, naturally, Arista works with its customers. Instead of hyping and making any pre-announcements, we are making sure architecture is 400 GB capable. We absolutely will support that you will expect to see trials and product capabilities from us. We're usually first to market. I don't see why we wouldn't be this time.

Jeff Kvaal -- Nomura Instinet -- Managing Director

Okay. When might first to market be, the first half '19 or a little earlier?

Jayshree Ullal -- President and Chief Executive Officer

When I introduce it, you will hear about.

Jeff Kvaal -- Nomura Instinet -- Managing Director

Alright. Thanks.

Jayshree Ullal -- President and Chief Executive Officer

And you know why I say that? A lot of this is dependent on the chip vendors and making sure we get a real production-worthy product and we're not just putting out samples that we can ramp nicely because it's not how we put unit 1 that matters, it's how we put unit 1,000 that also matters with the right quality, as Ken will remind me. Thank you, Jeff.

Operator

Your next question comes from Srini Pejjuri with Macquarie Securities. Your line is open.

Srini Pajjuri -- Macquarie Research -- Analyst

Thank you. I have a question on margins, Ita. So, I thought the Cloud Titan strength is somewhat negative to gross margin. I was somewhat surprised by the gross margin strength. Along the same lines, I'm trying to understand what's driving the operating margin guidance, almost 400 basis points in decline. Is it simply higher spending or anything else going on there? Thank you.

Ita Brennan -- Chief Financial Officer

You are correct that in a quarter where we have a heavier cloud mix, you should expect that to pressure gross margin, still within our 63 to 65 range. We have guided for that. We did task the team to focus on gross margin and focus on cost control, etc. this quarter to help offset that and they did a pretty nice job of that. Obviously, the higher service content contributed a little bit to that too. As a general statement, I would stand by the 63 to 65 with cloud pressuring it to the lower end depending on where we are in a quarter. I think that's the way to think about it.

The operating margin guide for the quarter is really the long-term model, which is 32% to 34%. We'll grow into that over time. It's not going to happen straight away. When you look at the investment, that's where we think we will be in a longer time.

Jayshree Ullal -- President and Chief Executive Officer

And we're going to absorb a fair amount of employees with the acquisition, right?

Ita Brennan -- Chief Financial Officer

Right.

Jayshree Ullal -- President and Chief Executive Officer

So, we will have more expense.

Srini Pajjuri -- Macquarie Research -- Analyst

Okay. So, you're including the OpEx from the acquisition in the outlook but not the revenue?

Ita Brennan -- Chief Financial Officer

Yeah. We're definitely including some expense there, but I would think about the 32 to 34 as a longer-term model that we're growing into, so it won't happen overnight.

Srini Pajjuri -- Macquarie Research -- Analyst

Okay. Got it. Thank you.

Jayshree Ullal -- President and Chief Executive Officer

The expense is guaranteed. The revenue is not.

Srini Pajjuri -- Macquarie Research -- Analyst

Makes sense. Thank you.

Operator

Your next question comes from Vijay Bhagavath with Deutsche Bank. Your line is open.

Vijay Bhagavath -- Deutsche Bank -- Analyst

Hi, Jayshree. Hi, Ita. I'm not James, unfortunately. Jayshree, I have a bigger picture question. Campus obviously has been a channel sale. So, I'd like to get your viewpoint, Jayshree on how you plan to build and scale and a channel and also your direct sales footprint now that you have wireless assets to sell, you have campus core switching. Thank you.

Jayshree Ullal -- President and Chief Executive Officer

Thank you, Vijay. That is a good question and one we won't get to overnight. As you were at the analyst day, you probably observed our first actual synergy in the campus will be our own customers, who already know us and love us for EOS. Our second will be as we build out our enterprise sales force, we fully expect that will be direct customer-driven and channel driven, and the third order would probably be especially a focus internationally, where we already have channel presence.

This is something Manny Rivelo and Anshul are working very closely on, but it's a work in progress and will take time.

Vijay Bhagavath -- Deutsche Bank -- Analyst

Thank you.

Jayshree Ullal -- President and Chief Executive Officer

Thank you, Vijay.

Operator

Your next question comes from Erik Suppiger with JMP Securities. Your line is open.

Jayshree Ullal -- President and Chief Executive Officer

I think we lost Erik.

Ita Brennan -- Chief Financial Officer

We missed the first part.

Erik Suppiger -- JMP Securities -- Analyst

Can you hear me alright?

Ita Brennan -- Chief Financial Officer

We can now.

Erik Suppiger -- JMP Securities -- Analyst

You can hear me OK?

Ita Brennan -- Chief Financial Officer

Yes, we can hear you now but you need to restart.

Erik Suppiger -- JMP Securities -- Analyst

I just wanted to understand -- you had noted that the long-term guidance is 32 to 34, but you're guiding for Q3 to be 32 to 34. Is that to suggest that there's upside to that in the near-term? Is that how you should be thinking about your Q3 guidance?

Ita Brennan -- Chief Financial Officer

I think that's the guide. We will have to absorb some cost from the acquisition, etc. on top of that. We're reserving the right to spend what we need to spend to do that. I think that's the guide. We've talked about this. We will grow into those investments.

Jayshree Ullal -- President and Chief Executive Officer

Exactly. We're going to continue to aggressively invest in R&D. As you all keep asking me, we also need to invest in the sales and marketing and enterprise channels. On one hand, you expect us to do that. On the other hand, you say, "Gee, why isn't it higher?" So, if we don't execute, we'd be higher, but we want to execute.

Erik Suppiger -- JMP Securities -- Analyst

Can you tell us how many people is Mojo Networks?

Jayshree Ullal -- President and Chief Executive Officer

Yeah, it's over 250 employees.

Erik Suppiger -- JMP Securities -- Analyst

Then real quick -- the Mojo solution is software. That's the only product in your portfolio that's just a software-based solution. Might we assume that your campus, this might lead you to make more campus products that will be white box and your portion will be just the software aspect of it? Is that reflective of a longer-term strategy?

Jayshree Ullal -- President and Chief Executive Officer

We'll take this question offline, but I'll give you a short answer to it. First of all, the Mojo product is not our first software product. We have four or five already in flight -- CloudVision, our macro segmentation security, our FlexRoute licenses, our TAP Aggregation DANZ products. So, we have a number of software-only options and CloudVision is probably the best example of that.

I think the way to look at this is software has to run on something. It does run on hardware. At any given time, you look for disruptive technology no matter which way it's packaged -- software-only, software plus hardware, or in the case of a lot of optics and cables, it's hardware-only.

So, we haven't really formed a strategy of software-only, but we do the right thing, which makes sense. In this case, it was such a natural synergy with the campus vision we have and the cloud-managed products we have with CloudVision that this is a very nice software-based acquisition.

Erik Suppiger -- JMP Securities -- Analyst

Very good. Thank you.

Jayshree Ullal -- President and Chief Executive Officer

Thank you, Erik.

Operator

Your next question comes from George Notter with Jefferies. Your line is open.

George Notter -- Jefferies -- Managing Director

Hi, guys. Thanks very much. I'm looking at the Mojo website right now. It says here they make access points and wiring closet switches. I guess I understand or I'm trying to understand the cognitive Wi-Fi tie-in here. But are you saying then you're going to discontinue those kinds of hardware-based products? I assume more likely you will continue to sell those in the marketplace.

And then more broadly, I guess I'm just trying to understand what the bigger picture is here for Arista. When you guys talked about pushing into campus, you really focused on the notion that you were going to be focused on the core, where you had some natural synergies with your data center switch business. Now, it seems like you're going more broadly into the campus. I guess I wanted to understand where you guys see the lines in terms of how you're going to compete on campus longer-term. Thanks.

Jayshree Ullal -- President and Chief Executive Officer

Sure. Thanks, George. That's a loaded, long question and I'll try to be concise. There's no question that our primary strategy, as Ken alluded to, is a combination of our cognitive management plane and our spline. We're leading with that. That's our strength. It's a natural extension from the data center.

That's where we expect to succeed first. Then, there's a diverse suite of edges. A majority of the edges will probably come from third-party partners or even competitors. So, we're not making any declaration or statement on Mojo's PoE switches or on our PoE switches. There's no stated intent at this time here.

What we bought Mojo for was their Wi-Fi, their cognitive Wi-Fi and the software capabilities associated with their access points. So, give us a chance to integrate the acquisition and decide what we do and don't do and how we do it, but understand that the epicenter of Mojo is not the switches. It's really the Wi-Fi.

Operator

Your last question comes from Hendi Susanto with Gabelli & Company. Your line is open.

Hendi Susanto -- Gabelli & Company -- Analyst

Good evening and thank you for my questions. Jayshree, in the last Q1 call, there's a concern that demand for 100 GB may normalize in 2018 after strong sales upside in 2017. I believe that was the main rationale of growth expectation in the mid-20%. Today, you sounded very optimistic about 100 GB and its longtail inflection point. My question is should we still be watchful that at some point we may see 100 GB to normalize?

Jayshree Ullal -- President and Chief Executive Officer

First of all, yeah, let me take this question in two halves, Hendi. Is 100 GB normalizing? No. We're still seeing a lot of demand. It's continuing to grow, both from a total available market -- I don't see much normalization, it's got multi-year growth -- and Arista's position. Now, obviously, 2017 was a real escalation year because we were literally going from nothing to everything. The next few years, the rate of growth will be slower, but the dollars will be very large and very healthy and very rich for Arista. So, that's one.

Then the second thing is, come back to the rate of growth again, the rate of growth has to do with the fact that we had two extremely exceptional quarters last year and that is more normalized to the mid-20s if you look more broadly, off some very large base of numbers. We're not talking about north of $500 million a quarter. That shouldn't be confused with the fact that we can do well and continue to do well in 100 GB.

Hendi Susanto -- Gabelli & Company -- Analyst

Got it. Thanks very helpful. Thank you, Jayshree.

Jayshree Ullal -- President and Chief Executive Officer

Thank you, Hendi.

Chuck Elliott -- Director of Business and Investor Development 

This concludes the Arista Q2 2018 earnings call. Thank you for all the good questions and for the opportunity to highlight our financial results and corporate achievement for you. I also want to mention that we have posted a presentation which provides additional information on our fiscal results, which you can access on the investor section of our website. We look forward to continuing the conversation with you during the quarter.

Operator

Thank you for joining, ladies and gentlemen. This concludes today's call. You may now disconnect.

Duration: 55 minutes

Call participants:

Chuck Elliott -- Director of Business and Investor Development 

Jayshree Ullal -- President and Chief Executive Officer

Kenneth Duda -- Chief Technology Officer and Senior Vice President of Software Engineering

Ita Brennan -- Chief Financial Officer

James Fish -- Piper Jaffray -- Analyst

James Faucette -- Morgan Stanley -- Analyst

Samik Chatterjee -- J.P. Morgan -- Analyst

Sami Badri -- Credit Suisse -- Analyst

Simon Leopold -- Raymond James -- Analyst

Alex Henderson -- Needham & Company -- Managing Director

Jason Ader -- William Blair & Company -- Analyst

Aaron Rakers -- Wells Fargo -- Managing Director

Jim Suva -- Citigroup -- Analyst

Steve Enders -- KeyBanc Capital Markets -- Analyst

Paul Silverstein -- Cowen & Company -- Managing Director

Mitch Steves -- RBC Capital Markets -- Analyst

Rod Hall -- Goldman Sachs -- Managing Director

Jeff Kvaal -- Nomura Instinet -- Managing Director

Srini Pajjuri -- Macquarie Research -- Analyst

Vijay Bhagavath -- Deutsche Bank -- Analyst

Erik Suppiger -- JMP Securities -- Analyst

George Notter -- Jefferies -- Managing Director

Hendi Susanto -- Gabelli & Company -- Analyst

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