Arista Networks Inc (ANET) 2015 Q2 法說會逐字稿

Welcome to the second-quarter 2015 Arista Networks financial results earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded and will be available for replay from the Investor Relations section at the Arista website following this call. I will now turn the call over to Mr. Chuck Elliott, Director of Investor Relations. Sir, you may begin.

Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me on today's call are Jayshree Ullal, Arista Networks' President and Chief Executive Officer; and Ita Brennan, Arista's Chief Financial Officer. This afternoon Arista Networks issued a press release announcing the results for its fiscal second quarter ended June 30, 2015. 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 FY15, industry innovation, our market opportunity, and the impact of litigation, subject to the risks and uncertainties that we discussed in detail in our documents filed with the SEC, specifically our most recent Form 10-Q and Form 10-K, and which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call.

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. Thank you, everyone, for joining us this afternoon for our Q2 2015 earnings call. I am pleased to report our fifth consecutive beat as a public company. Consistent with prior quarters, customer demand for our 7000 series EOS-based platforms drove results that exceeded the consensus.

From a geographic perspective, our customers in the Americas generated 77% of our sales, and 23% was generated internationally from EMEA and Asia-Pacific. We are witnessing continued traction with financials and modern enterprises, and significant contributions from many of our cloud titans and service providers.

Revenue grew 42% year-over-year to a record $195.6 million. Service contributed more than 10% of overall revenue. We delivered non-GAAP gross margins of 65.8%, resulting in a non-GAAP earnings per share of $0.54, growing 50% year-over-year in our competitive and dynamic industry. We now have over 3,390 customers and continue the acquisition trend of one to two new customers per day.

This quarter we had many key highlights. We announced a transformational network-wide, state-based management platform called CloudVision. CloudVision is a very meaningful entry into software-based subscription services, offering a network-wide operational control. It dramatically improves network change control for many of our customers.

CloudVision offers a unique array of capabilities differentiated by a single point of workload integration, network-wide rollback, and workflow automation and visibility. We do expect the results of CloudVision to be a multi-year journey and much more measurable in 2016 and 2017.

CloudVision has been endorsed by many of our new and existing partners, including VMware NSX, Microsoft Hyper-V and Windows Server, HP, Dell, F5, Infinera, Palo Alto Networks, Nuage, Rackspace, and Supermicro. Speaking of partnerships, we formalized our converged infrastructure solution with HP for cloud-class networking with HP's Compute and OneView integration. We believe this is an important step, not only for us, but the industry in moving towards converged solutions for mainstream enterprises.

We have now surpassed 5 million cloud networking ports and cumulative overall shipments. Our first million ports, to put this in perspective, took about four years. Our 5 millionth port was achieved in approximately 1/10 that time. We are therefore forecasting a cumulative revenue that will exceed in excess of $2 billion by the end of this year, as we continue to feel good about gaining market share and customer relevance in our 10-, 40-, and 100-gigabyte ethernet data center market.

Now I would like to turn the call over to our new CFO, Ita Brennan, for further financial details. Welcome, Ita, to your first earnings call with Arista Networks.

Thanks Jayshree, and good afternoon. I'm pleased to announce the results for the second quarter of 2015, my first quarter with Arista.

This analysis of our Q2 results and our guidance for Q3 2015 is based on non-GAAP, and excludes all non-cash stock-based compensation expenses and legal costs associated with the ongoing lawsuit. A reconciliation of our selected GAAP to non-GAAP results is provided in our earnings release. Total GAAP revenues in Q2 were $195.6 million, up 42% year-over-year, and comfortably above our guidance range of $183 million to $191 million.

We experienced good momentum across all key verticals in the quarter, and we're pleased to see our service revenues continued (technical difficulty) percentage of revenue. International revenues totalled $45 million or 25% of total revenue. While we are focused on expanding our international footprint, you should expect our geographical revenue mix to fluctuate on a quarter-over-quarter basis depending on the timing of US and international deployment. Although not impacting our financials at this point, CloudVision has demonstrated some good early market acceptance in the short time since our product launch, and we expect to see good traction into 2016 and beyond.

Overall gross margin in Q2 was 65.8%, down slightly from Q1 at 66.1%, and just above the upper end of our guidance range for the quarter. As a reminder, the biggest driver of volatility in our gross margin number is customer mix, and to a lesser degree, product mix, with large customers earning higher discount levels. While our four verticals were well represented in our revenues for the quarter, we also experienced good traction with several of our cloud titan customers.

Operating expenses for the quarter came in at $74.7 million, or 38% of revenue, up 33% from the prior year and 11% from the prior quarter. Our spending increases were largely focused on additional personnel in sales and marketing and R&D, higher prototype expenses, and additional consulting costs as we complete our first year of SOX compliance.

Our operating income for the quarter was $54 million, or 27.6% of revenue. Other expense for the quarter was $0.4 million and our effective tax rate was 27.6%, resulting in net income for the quarter of $38.8 million, or 19.8%.

Our diluted share number for the quarter was 71.2 million, resulting in a diluted earnings per share number of $0.54, up from $0.50 in the prior quarter and up over 50% from the prior year. Legal expenses associated with the ongoing lawsuit came in at $9.9 million for the quarter, in line with our outlook on the last earnings call. As a reminder, these expenses are excluded from the non-GAAP results discussed above.

Now turning to the balance sheet, cash, cash equivalents, and investments ended the quarter $552 million. We generated $52.6 million of cash from operations in the June quarter, up from $20.8 million in the prior period. DSOs came in at 57 days, flat to last quarter. Inventory turns were 2.7 times, down from 2.8 in Q1.

At the end of Q2 we held approximately $100 million in inventory, including $28 million of raw materials. Our inventory planning strategy is to leverage inventory [buffers] where needed to ensure that we can flexibly respond to our customers' needs. That said, this will be an area of increased focus in coming quarters as we look to improve our inventory metrics.

Our deferred revenue balance was $164 million, up from $133 million in Q1. This balance is largely made up of short- and long-term service contracts, with some product deferrals related to acceptance terms and future deliverables. Accounts payable days were 59 days, up from 43 days in Q1. Capital expenditures for the quarter were $3.6 million.

Now turning to our outlook for the third quarter and beyond. We are pleased with our financial performance in the first half of 2015, with revenues up 47% and earnings per share up 75% on a year-over-year basis. We continue to increase our market share and gain traction across key verticals and customers.

Market remains competitive from a pricing perspective, and as mentioned above, our gross margins will fluctuate depending on our customer mix. We will continue to invest in the growth of the business, both in terms of increased headcount and the build-out of infrastructure as we expand our worldwide presence. We will do this in a judicious and thoughtful manner, and within the parameters of our business model, which calls for operating expenses of approximately 40% of revenue.

With this as a backdrop, our guidance for the third quarter, which is based on non-GAAP results and excludes any non-cash stock-based compensation expenses and any legal expenses associated with the ongoing lawsuit, is as follows. Revenues of approximately $208 million to $212 million, gross margin of approximately 63% to 65%, and operating income of approximately 25%.

Our effective tax rate is expected to be 28% to 30% with diluted shares of approximately 71.7 million. Please note that based on our current understanding, we expect costs associated with the ongoing lawsuit be approximately $15 million for this quarter, with this quarter representing a peak expenditure quarter as we engage directly in trial activity.

I'll now turn the call back to Chuck. Chuck?

Thank you, Ita. We're now going to move to the Q&A portion of the Arista earnings call. We are expecting a lot of great questions; however, due to time constraints I'd like to request that everyone please limit themselves to a single question. Thanks, all.

(Operator Instructions)

Subu Subrahmanyan, The Juda Group.

Thank you. Jayshree, if you could talk a little bit about customer mix and product mix, you mentioned all four verticals were strong. Were there any particular standouts between the segments and between -- similarly, between modular and fixed form factors? And then the other question I had was on carrier, can you talk about carrier opportunities, how they're playing out this year with Tier 1 telcos and what the applications there may be?

Right. Thanks, Subu. First of all, on the vertical mix, we were very pleased with the balance of all four. The cloud titans were the top performers, followed closely by the service providers and Tier 2 cloud hosting providers, but I would say the financials and high-tech enterprises are holding and growing very nicely as well. So all four verticals performed in a balanced fashion. Our top 10 customers included customers from all four verticals.

Specifically in terms of carrier, as you well understand, carrier cycles are extremely long; it's a process we expect to be multi-year. We are getting early acceptance in the Tier 2 carriers; we are starting to make small inroads in the Tier 1 carriers as well, but nothing we would comment on or describe immediately since they're multi-year journeys.

In general I would say the mix between modular and fixed remains similar. We've always said that leaf or fixed is, in terms of product mix about half, and then the modular and the optics and associated accessories is the other half, and we continue to feel like the most well-accepted spine in the industry and the reception has been very good and continues to be good.

And if I can briefly follow, Jayshree, on the carrier side, the initial traction, is that for applications within the data center or are you starting to see inter-data center applications as well?

That's a good question, Subu. As you know, our focus, our market share, our relevance is all in the data center. The carriers have a lot more expenditure outside the data center, but Arista's focus, today, right now, is in the data center.

Got it. Thank you.

Jeff Kvaal, Nomura.

Yes, thank you very much. There has been some concern in the marketplace about the pace of data center spending heading into the second half of the year. I'm wondering if you could share with us what you are seeing from your customers about the pace of their purchasing behaviors in aggregate. And any reasons why you think there might be a slowdown either in the second half of next year -- or this year or heading into next year. Thank you.

Thank you, Jeff. As far as we can tell, our TAM is still extremely big and we're less affected by macroeconomic situations and paces. Specific to the data center in the four verticals I referred to, we're seeing good pace in all four of them. I would highlight that cloud titans as particularly high pace for 2015 in general for the first half, and we continue to remain positive about the second half as well.

Okay. So your visibility, Jayshree, then, is as good as it's been if not better.

Jeff, I've always said our visibility is short-term but especially the cloud provider, so we never know beyond a quarter or two, so I can't say about next year but I feel good about this year.

Thank you.

Alex Kurtz, Sterne Agee.

Yes, thanks for taking the question. Jayshree, can you just remind us about how you think about longer-term gross margin targets relative to the cloud titan mix as that grows as a percentage of overall revenue? You guys have continued to execute pretty well in the margin line here and the cloud titans are obviously the number one vertical, so is there a magic mix level where they get the 40% to 50% of revenue and you would really expect to see the margins get impacted by that? Or maybe the pricing isn't so bad with that group of customers.

Right. So Alex, first of all welcome to your first call, I think this is your first one since you started covering us, right?

Yes. Thanks. Glad to be here.

Good to have you here. What we have said in the past when maybe you didn't cover us is there is a big difference between the gross margin from our cloud titans and that the rest of the customers. And the driver is really volume.

Our cloud titans drive significant volume and pricing to our customers and therefore gross margin is very much driven by volume. So there is a delta of at least double-digit points between the gross margin we tell you guys about and share with you and what they can be with the cloud titans, obviously lower in case you thought they were higher, by the way. So that continues.

Having said that, we have also -- coupled with that we also believe that we are going for footprint and market share. And there are a number of transitions going on, there's a number of competitive things going on. The transitions going on is 1 gigabyte to 10 gigabyte in the leaf, and then also 10 gigabyte to 40 gigabyte and 100 gigabyte in the spine. We also see many transitions that will come up next year for 25 gigabyte and 50 gigabyte.

So speed transitions means you have to drive the speed at higher speed at lower price, and that can have an impact on gross margin because you're trying to provide better price performance. So that's always the case.

And then, as we go for a [race] to footprint, we would look to gain market share and not always pay perfect attention to our market share. So while our gross margins -- all this as a backdrop to say that while our gross margins today are in the 65%, they have come down from last year's 67%, and we project our long-term gross margins to be more consistent with the industry gross margins of 60% to 65%. Obviously in that process we hope we'll also gain share and grow to be a billion- and multi-billion-dollar company.

Great. Thanks.

Thank you, Alex.

Hendi Susanto, Gabelli & Company.

Hi. Thank you for taking my questions and congrats on great results. Jayshree, I have a question. Since we've been hearing more about the transitions towards 25 gigabyte and 50 gigabyte, so in terms of timing and the multiple round of transitions, like, what is your expectation and outlook for the transition?

Yes, Hendi, that's a good question. First of all I think this is -- the 25 gigabyte and 50 gigabyte transition will take time. This spec only got finalized this year and the chips are only coming into the marketplace, really, effectively 2016.

So the Company Arista has been through seven product transitions in the [truly] seven years, so we are very comfortable that the 25 gigabyte and 50 gigabyte is another speed transition, but very similar to a lot of our leaf product transitions we have done already in the 10 gigabyte space or the 40 gigabyte space. So we don't see this as a dramatic event but a natural, if you will, progression event of price, performance, and speed.

Where we think this will -- 25 gigabyte and 50 gigabyte will have more impact is especially for storage applications. I think general purpose compute can and will remain at 1 gigabyte and 10 gigabyte in many cases, and then the high-performance storage may have a great desire for 25 gigabyte and 50 gigabyte.

In terms of the spine, we think the major spine components will be 40 gigabyte and 100 gigabyte. So there is room for every application, if you will, and every speed, and that's why we're doing so many of them.

Thank you, Jayshree.

Thank you, Hendi.

James Faucette, Morgan Stanley.

Thank you. Just quick follow-up on the margin question, you've made it clear, Jayshree, that you intend the and expect that the gross margin will come down to be more like industry averages. On the other hand, you've historically looked at being close -- or below the 25% operating margin level but this quarter you're guiding for that level. Do think that 25% is kind of the -- should be the new long-term benchmark, or is there something anomalous in this quarter that you are a little bit more confident on that?

And then I wanted to ask from a business development standpoint if the HP partnership and go-to-market work that you're doing there has started to have an impact and how you are thinking about that and its opportunity to increase your addressable market going forward. Thanks.

Thank you, James. I'll take the second question first and then Ita, if you don't mind, I'm going to pass the first one, especially the 25% operating margin and gross margin, to you.

I couldn't be more pleased with the HP partnership. It's one we've been working on for several months before it came to fruition, and HP as you know is not a company that would do this without thought. The converged infrastructure and this market is changing rapidly, changing for compute, it's changing for storage, it's changing for networking.

Quite frankly it's a market that Arista has not played in. We could not have played in it without a major market partner like HP. HP is a leader in compute and storage. This is an acknowledgment of a best-of-breed network partner by HP. We're working very nicely in the converge infrastructure, and really providing solutions of scale and high availability.

We announced this partnership in HP Discover, I think it was in June, right? So we've had about four to six weeks here now, and the pipeline and traction has been exciting. We've already had single-digit customer wins and so I'd say it's a good start but a long way to go.

And James just to come back on the gross margin question, then, I think if you think about our long-term model in that 60% to 65% range, but as you'll see our kind of near-term guidance, we're still sticking to the 63% to 65%.

I think that's because we think that lower end of that range probably happens over multiple years, and obviously in that timeframe we're also adding some capabilities, stuff like CloudVision, services growth, we'll see how all that plays out. But clearly there's some puts and takes in both directions all the time. So I think that's probably the way to think about it, in the near-term we're sticking to that 63% to 65%.

In terms of operating margin, I think the business model at 40% of revenue is still a good, solid way to think about it. We're growing into that but we are making investments, we're investing in sales and marketing, we're investing internationally, and I think a 40% OpEx level is probably the right way to think about that piece of it.

Sanjiv Wadhwani, Stifel.

This is [John Michael] for Sanjiv. I was wondering if you could provide us an update with the lawsuit against Cisco.

Okay. Hey, Marc, do want to take that one as my General Counsel?

Sure. I'd be happy to.

Thank you.

Thank you, Jayshree. So with respect to the ITC investigation the schedule is as follows. The hearing for the 944 is going to begin on September 9 and continue through September 17. The hearing for the 945, the second investigation, will start on November 9 and continue through November 20.

Our team has developed a good defensive strategy for the cases and we're in that midst of preparing for trial today. We've also filed seven IPR petitions and we are currently weighing the decision on those by the (technical difficulty) as well.

With respect to the copyright case, that trial date is set for August of 2016 of next year. We're also currently engaged in discovery for that case.

As you [probably also] have OptumSoft litigation right now. That has been bifurcated into two trials. The first will consist of a trial starting September 14 of this year, where the court's going to determine ownership of specific disputed software packages, and again we've developed a good defense for that case and we're currently preparing for trial.

Thank you, Marc. That was good.

Thank you.

Ryan Hutchinson, Guggenheim.

Hey, good afternoon, guys. So Jayshree my question's around the merchant silicon strategy. Clearly, on the one hand it gives you a significant time-to-market advantage, but on the other hand the work we've done suggests that there could be some potential delays with the Broadcom Jericho chipset. So the question really is, one, is it true, and two, does it matter? And how would it impact your ability to move deeper into the routing opportunity that you've alluded to over the last several quarters as we look to 2016?

Right. Thank you, Ryan. As you know, our strategy very much depends on excellent software running on different types of merchant silicon. Everybody gets access to the same merchant silicon. Arista has always been very unique in our ability to make that merchant silicon do unique things, whether it's with our drivers, our firmware, our customization, our deep understanding of silicon.

We work with three types of silicon today. You pointed to one of them, Arad, which will be moving to Jericho, the Trident chipset which has moved T+, T2, you name it, and also the Intel Alta chipset, and at any given time we also have one or two others we're looking at, so merchant silicon and the lifecycle and execution of those products and vendors is something we depend on.

But we don't depend on only one architecture. We already have three and at any given time we are looking at two others as well. So having been in the silicon industry many, many years ago, I can tell you I don't know a single chip that doesn't slip. And I can tell you there's not a single piece of software I know that doesn't have a bug; those are just kind of normal ways of operating and engineering.

So while it's not my place to comment on the expertise of those chips and why they slip, we do tend to accommodate that and it generally doesn't affect our schedules and our product deliveries and our market plans, because we account for them and we always account for chip vendors having a metal spin or re-spin, et cetera.

So in terms of addressing market, as Ryan, you and I have very much discussed, our total available market for the data center is $6 billion going to $12 billion. That is our primary and sole focus. Any adjacencies and additional things we do will come in the next few years, but we're not depending on them for chips or existing execution in our primary markets.

Perfect. Thank you very much.

Thank you, Ryan.

Jess Lubert, Wells Fargo Securities.

Hi guys, thanks for taking my question and congratulations on another strong quarter. First for Jayshree, on the international mix, can you share with us if the 23% of revenue from overseas customers included business with US customers building out overseas and if you are starting to see incremental success with international accounts?

And then for Ita, it looks like you saw a fairly large sequential and year-over-year increase in deferred revenue so was hoping to better understand some of the dynamics there, to what extent this reflects some short term business that may have pushed out from Q2 to Q3, or if it's all services. Any additional input there would be helpful. Thanks.

Thank you, Jess, for the good wishes. We are pleased with the international progress this quarter.

So first to clarify, the numbers I gave you were completely organic. So any of the cloud titans, et cetera, are not counted in the international numbers. All of the international numbers is organic growth, so that's a nice number.

In terms of contributions, in Q1 was very high from the cloud titans. In Q2, we actually saw contribution from new customer wins. Particularly pleased with some wins in Asia-Pac and in Europe, but especially Asia-Pac. And so we're -- while we would like to see even more execution internationally, we are pleased with the hiring and the progress we are making there given we really only started our efforts recently in the last 6 to 12 months.

We've established subsidiaries in all the major countries, we've started active hiring in all of these countries and I think we'll see some encouraging wins, hopefully resembling the same four verticals that you see here in the US internationally. Ita you want to take the second part?

Yes, so in terms of deferred revenue, I mean the vast majority of our deferred revenue is really services-related and I think if you look at the trends in deferred revenue over the last number of quarters, it has been ticking up nicely just based on the services growth and the growth in services. There is a smaller amount of product-related deferred revenue that's there just related to some time-out type acceptance terms in some contracts, but again, the vast majority of it is in the services side.

And is the growth that we're seeing in services, the deferred growth, is that driven by some specific large projects, is that how we should think about that?

I think the way to think about it, Jess, is tied to the 5 million ports I just told you. We're now experiencing more service contracts, service renewals, and realization from that, that we didn't have.

So higher attach rates versus necessarily bigger projects?

Right. And then you renewals are kicking in too, obviously, and you're having renewals happen, with our growth rate, you're having renewals happen throughout the year more than maybe what you would see in a more steady-state business where that would tend to be towards the end of the year, we have a steady kind of growth in renewals, our revenue as well.

Thanks, guys.

Thanks, Jess.

Kulbinder Garcha, Credit Suisse.

Thanks. I joined the call late but my question is basically around revenue [guidance]. Jayshree, this year do you think all four verticals will be roughly equivalent again or will the cloud be much bigger than the others? And did you have any -- how many [sorry] above 10% customers did you have? Maybe you answered that but I just wanted to clear it up? (technical difficulty) Thanks.

Kulbinder, thank you. I was having trouble following about every other word so I'm going to rephrase your question. Are you asking about the diversity in verticals this quarter or our forecast for next quarter?

How do you expect the year to end up?

Expect the year to end. Okay, got it. Well, we've had a very balanced first half, so, and at the same time, I believe the -- one comment I really want to make on the call, titans, is it's not about one customer concentration. As you know, we are in six out of the seven major cloud titans and we're very pleased by the acceptance and expenditures of many cloud titans.

So while we are deeply penetrated in one, in especially Microsoft, we are pleased that the cloud titans in general are all growing, and as you know, they're large numbers and if they grow then that helps our numbers, too. But we're also seeing, as I said, this quarter, good wins in financials and high-tech enterprise.

High-tech enterprise is comprised of many subverticals if you will, the web services, software companies, high-tech companies that manufacture silicon, so it's a large catch-all bucket. So all four verticals I expect through the year will be well represented and diverse. They may be lumpy in the quarter but so far we haven't seen it this quarter or last quarter.

Thank you.

Thank you, Kulbinder.

Simona Jankowski, Goldman Sachs.

Hi Jayshree, just a couple of questions. The first one is can you just give us an update on your EOS as a subscription product? How that's going, what the early feedback has been. And then, as you know, Juniper recently announced its entry into the data center spine segment with 40 gigabyte products. Can you just talk about how you view them as a competitor there?

Right. On the EOS as a subscription project, I would say we have received small acceptance still and it is mostly in entry-level smaller customers. They're not your typical big large data centers. More trials, I would say, than large scale production deployment.

I think customers are still getting used to the model. They're -- it is not one they are familiar with, their old 20-year-old habit of just buying everything together. So it's only the SMB customers who want to try and buy or feel their way or have smaller budgets that are going in that direction for EaaS.

Specific to Juniper, I am not seeing anything different. We have a great deal of respect for our competition. We see Juniper in the core; we haven't seen them much in the data center.

Okay. Thank you.

Thank you, Simona.

Mark Sue, RBC.

Thank you and sorry for the background noise. Jayshree, if we look at the growth opportunities ahead, is there a way you could rank order how we should see the TAM opportunities, extension opportunities, would it be international? Would it be new market agencies? Or how you are prioritizing your resources? That would be helpful.

Right. Mark, I'm going to probably guess a little here, so I don't know if I have the perfect answer. But I would say our -- we have a four-pronged growth strategy towards our billion -- first billion, let's say. And I would say they are four-fold.

The first one is deepen in the four verticals. Mostly we think we're already there and we're achieving a lot from it and while that's true I would say we've barely scratched the surface of many. There's a lot of customers there, there's a lot of spend there, and there's a lot of awareness of Arista there, there is a lot of appreciation of our OS and our programmability there, so deepening in our verticals will give us the fastest and largest growth, I believe.

The second is what you mentioned, I think the expansion to international. We started, frankly, late and we've been slow. We've only really realistically started this year. So I think any expansion we do on the international to replicate what we've done in the US will give us a growth potential the next three to five years.

And possibly (technical difficulty) we also expect that our partnership with HP will give us expansion internationally, our technology partners in general including VMware. So the combination of our technology partners and international, I would agree with you, is a growth expansion strategy. The third one, I would say is (technical difficulty).

Thank you. [I'm staying at] a billion. (technical difficulty)

While I don't think our software subscription will be material to our revenue short term, it's a very strategic part of our growth strategy. And Ita and I and our Senior Management team here value it deeply and so do our customers. There's a lot less people and assets available to absorb technology and make technology work for you and cut costs that are both CapEx and OpEx, and so this is a key indicator for OpEx control.

And finally, last but not least, I've always committed to you that our foremost and primary commitment is the data center but we do not preclude adjacencies. We believe the data center is the primary and core market, but many of the adjacent markets will come to us. And that will be a natural -- longer-term part of our prospects.

Thank you.

Thank you, Mark.

Simon Leopold, Raymond James.

Great, thank you very much. Maybe my imagination's playing the best of me but I kind of think I'm hearing a little bit of contradiction in some of the discussions about verticals. It sounds like you've talked about balanced verticals in terms of all four but you also sound more constructive, more positive, on web scale, the titans. You emphasized several rather than the one big one.

I want to try to understand if and what may be changing among the web titans, and one of the things I'd like to get a better understanding of, we're hearing some suggestion of maybe a shift away from white box switches for all applications and maybe embracing solutions like yours for the higher end applications. And I'm really looking at the web scale guys other than Microsoft that clearly has already embraced Arista. Thanks.

Okay, Simon. So first of all, no contradiction intended. The first quarter and the second quarter have shown good balance on our four verticals. If I had to cite the verticals that contributed the most, it would be the cloud titans and the service and cloud providers.

But I don't want to underestimate how well the financials and enterprises have done. Their TAM and their spending is lower but their acceptance of Arista in these general purpose clouds as they build general purpose data centers and private clouds, I'm very pleased with. So I don't mean that to be a contradiction. I think they're actually quite consistent. (multiple speakers)

And are you seeing them embracing your solutions rather than white box alternatives to a greater degree than they might have six months ago?

Okay so let me address it. So first of all, the first part of your question was did you have balance or did you not? And absolutely we had balance and I explained the top two verticals.

In terms of white box, first of all, we do not see the white box at all in all four verticals. I just want to be clear on that. We have seen the white -- we have to 3,390 customers. I have seen the white box phenomena in maybe single-digit customers out of the 3,390, just to be really clear.

When we do see it, and this is something we're very cognizant of, all good organizations that have engineering capabilities will always have the right to experiment and will continue to experiment on single use cases and what kind of cost they can get and what is core and what is context for them. So as I've explained before, Simon, in the Facebook example, we work with their internal implementations to enable value on Wedge and on the FBOSS through our EOS. So if a company has white box, that doesn't mean it's mutually exclusive and Arista can't be there.

That's very helpful.

To answer your question even more explicitly on the last six months, we have not seen an uptick in white box interest. It's been about the same, it tends to be single-digit customers, and it tends to be largely experiments in labs. There are very few instances of captive production-based white box implementation.

Thank you.

Thank you, Simon.

Paul Silverstein, Cowen and Company.

Thanks, guys. Jayshree, I guess in part you just answered the question, but let me ask you with the broader question on competitive landscape, and the direct question being have you seen any meaningful change? I know you just addressed the white box piece of it, but obviously there is Cisco and others. So any change there?

And then, it's not a question but it's a statement and I apologize if I put you on the spot, but I'm doing it by design, and I know Ita just arrived and so my apologies to Ita.

But I would strongly encourage you -- I understand why you don't want to do it, but I would strongly encourage you all for the benefit of investors, sell-side analysts, and yourself to provide the vertical breakout and not just in the general terms that you have, and I appreciate that in terms of your comments about the balance. But I think it would help us and it would help you to provide the actual exact disclosure. With that said, I'll go back to the question about the competitive landscape. Thank you.

Thanks, Paul. Feedback taken. Appreciate it. We will definitely look into it.

Regarding the competitive landscape, we have not seen significant change. We have had to compete in the last six quarters, I would say, more with paper tigers than with reality.

In the last recent quarters, as the products come to market, it has actually strengthened the conviction of our customers even more that we have the best platform and product. And what I mean by that is not just speeds and [speeds] and buffering and latency and power and all of that good stuff that we derive from our chips, but really the programmability of our software stack and the 10-year endeavor we put into that. No one is coming close.

A lot of people use the words scripting, programmability, DevOps, NetOps, no one has come close to actually implementing the level of depth and it's reflected, Paul, as you well know, in our R&D investment which is our top and most significant investment. So while it can look on paper like people have caught up, when people actually evaluate our product, we technically win 9 out of 10 times. Maybe 10 out of 10 times. Technically.

And so beyond the technical aspect, if we looked at your win rate, I mean I appreciate it's not just about technicals, but if we looked at your win rate has there been any change for better or for worse?

No. I think our win rate has been equal or better. Now, understand that with our coverage we probably don't see everything. So I can only speak to what we see, but in the scope of what we see, our win rate is equal or better.

All right. One final related question in terms of the pricing environment, any meaningful change?

No, I was just looking at the ASP trends, so no, they haven't changed much in the last two, three quarters.

I appreciate it. Thank you.

Thank you, Paul. No worries putting me on the spot.

Erik Suppiger, JMP.

So first off, for Marc on the legal proceedings, I think you're going to court twice in September. How quick do you expect the courts to come back with their decisions on the patents and the infringement?

And then, secondly, you're halfway through the year now. In the past, you've talked about Microsoft as a customer that would come down as a percentage of revenue but continue to grow in terms of dollars. I'm just checking, is that still your expectation for 2015? Would you expect the dollar sales to Microsoft to continue growing year on year?

Marc, you want to take the legal question, or do want me to do the Microsoft one first?

You can take Microsoft.

Okay. So I'll answer the second question first while I still remember the answer. Erik, Microsoft continues to be an extremely important top customer for Arista, very strategic. We expect that -- we generally said we expect their spend to be flat to slightly down or flat to slightly up. At the moment I would say we're feeling better about flat to slightly up.

Are you talking about in terms of dollars when you say that?

I'm talking strictly about dollars. Obviously they will continue to come down as a percentage of our overall revenue because they're growing. But as a spend in dollars, we feel good about their spend and we feel that their investment in the cloud is having a direct correlation to their investment in Arista.

Very good. Okay.

So with respect to the timing, so with the ITC, as you know, the first case is in the 944 and that's going to happen through December. The administrative law judge decision for that, the initial determination, occurs January 27 of 2016, and then it goes to the commission and the commission makes a decision on May 27. And then that goes to a presidential review in 60 days, that gets to July 27.

And the 945 case in November, that initial determination by the administrative law judge does not occur until April 26 of next year. Final determination by the commission is August 26, and then the presidential review of that isn't until October 26.

So a long ways here, another year or 1.5 years ahead of us, right? But so Marc, despite all of the overheated rhetoric we've been hearing for Cisco blogs about Arista's brazen copying, we think the only thing brazen about this case is the extreme length Cisco has gone to, right? Our customers have shown unwavering support.

I think that's right, Jayshree. I think ironically, one of the things that we find interesting about this case is that it appears to us, anyway, that Cisco is behaving very much like a patent troll, which is pretty much what they've spent the last decade condemning. They're choosing to assert patents against widely-implemented, industry standard feature functionality that exists in all network switches today, and they're twisting the language at some of the patents to attack features that the patents were never intended to cover so we find this an ironic strategy.

When you talk about those decisions, though, for the Markman Hearings, when would they be coming back to determine which patents are applicable for the case?

So with respect to the Markman, actually, that -- you're asking about the Markman or are you asking about the decisions by the judge with respect to the trial?

The Markman.

So on the Markman case, the Markman trial was for the 945, that only (multiple speakers) the two investigations. We're still waiting on the Markman order. That would apply to the six patents that are in the 945 case. The decisions on those should occur, we expect, sometime within the next couple of weeks and then those would apply to the 945 hearing that we're going to be having in November.

Okay. Very good. Thank you.

Vijay Bhagavath, Deutsche Bank.

Yes. Thanks. Calling on behalf of Brian, hi Jayshree.

Hi, Vijay.

Hi. A question on the Tomahawk plan, we get asked this question a lot by clients. You had some understanding of the waterfall and the product cycle you see for Tomahawk. Do you think the product cycle starts kicking in from the fourth quarter? And in that case they would see in about seasonal Q1 of 2016 with more 100 gigabyte ports in the mix?

And in general on a full-year basis next year, how would you view 100 gigabyte approximately as a percentage of your mix because clearly you have your customers, especially the cloud titans, doing 100 gigabyte work in the leaf and in the spine. Thanks.

Right. Yes. Good question, Vijay. I think both the transitions will be slow and gradual and it will be multi quarters; it will not be just overnight in Q1 2016. In general speed transitions take time, as you know, Vijay. I mean we may realistically think they should happen, but the time from when they decide it to happen to when the customer actually makes it happen is much longer, so I think Tomahawk and 100 gigabyte in the spine will happen of throughout 2016 and for that matter 2017.

Perfect and then a quick follow on would be on data center routing with the new merchant silicon like Jericho. Are any thoughts on the product cycle ramp for that? Would that be second half of next year? Give us your view. Thanks.

So we haven't really commented on our WAN and adjacency strategies and we look to do that in the future when they're ready. But in general I think what you're seeing here is that traditional networks where you built switches in the campus and routers and the WAN and branches with routers, et cetera, all this work was often called places in the network are coming together. And I think you're seeing much more of an integrated, seamless, pin structure. And so I think this is going to apply to the WAN too, as interfaces move more and more to ethernet and routers move more and more to routing and the noun becomes an adjective, if you will.

These will not be market segments. And existing companies may see their TAM shrink as these become features on products, so we see the spine as becoming a very relevant platform for the data center and cloud today but we don't preclude the possibility of other features such as routing, especially as you pointed out, with [modern] silicon coming.

Thanks again. Thanks.

Thanks, Vijay.

George Notter, Jefferies.

Hi, thanks very much, guys. I was curious about the 5 million port milestone. I think if I had this correct, you passed both the 4 million and 5 million port milestones this quarter. Is that correct?

That's correct. I think the last time -- good observation, George. You're the only one who caught it so we got to give you an award. But we announced the 3 million and we never announced the 4 million, and we went straight to 5 million and maybe we should go straight to 7 million or 10 million next time, but it shows the velocity and acceptance of our ports and the migration to high-speed is happening in our (multiple speakers).

Got it. Okay. And then I guess the real question behind this is again, I think if I have it correct, it took you three quarters to pass, effectively the 4 million port mark because three quarters in a row you (multiple speakers).

It took me -- what I tried to say, maybe I got too cute with it, I'll try again. It took us four years, 48 months, to do our first 4 million ports. So from inception, basically, end of 2008 to now, first 4 million ports took us 48 months. The last million ports took us 1/10 that time, less than 4.8 months.

Got it. Okay. I guess my understanding is that for the September quarter you were north of 3 million ports, you were also north of 3 million in the December quarter, and then also at the end of the March quarter? So it took you those three quarters to ship an additional million ports, and yet just in the June quarter you shipped 1 million ports.

So I'm wondering if there's something that's going on here in terms of pricing because I'm not seeing certain -- lots and lots of growth, certainly, in the June quarter, but it seems like the port shipments relative to revenue were much bigger so I'm just wondering if there's anything that's changed on pricing. That's the gist of the question.

I think the one fact that's incorrect in your assumption is we didn't stay at 3 million ports for four quarters. We just did report when the 4 million happened.

Got it. Okay. I think you just told us it happened in the June quarter as well as the passage of the 5 million milestone.

No. We just went straight from 3 million to 5 million and we reported the cumulative being 5 million so don't assume all 2 million ports happened in one quarter.

I see. Fair enough. Okay. Thank you very much, guys.

Thank you, George.

Sanjiv Wadhwani, Stifel.

Hi, I just had another quick question on whether or not there was a 10% customer in the quarter. Thank you.

We don't comment on 10% customers in the quarter, but the answer is no.

Okay. Thank you.

All right. This concludes the Arista Q2 2015 earnings call. I also want to mention that we have posted a presentation which provides additional perspective on our Q2 FY15 results, which you can access on the Investor section of our website. Thank you to everyone for joining us today.

Thank you for joining. Ladies and gentlemen, this concludes today's conference call. You may now disconnect.