Arista Networks Inc (ANET) 2015 Q3 法說會逐字稿

Welcome to the third-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 third 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 fourth quarter of FY15, industry innovation, our market opportunity, and the impact of litigation, which are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically in our most recent Form 10-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 Q3 2015 earnings call. I'm pleased to report our sixth consecutive beat as a public company. Consistent with prior quarters, customer demand for our 7,000 (inaudible) US-based products drove results that exceeding the consensus. From a geographic perspective, our customers in the Americas generated 78% of the sales and 22% was derived internationally from the EMEA and Asia-Pacific theaters.

We are witnessing balanced traction across our familiar four verticals, our Cloud Titans, financial, high-tech enterprises, and web and service providers. Revenue grew 40% year over year to a record $217.5 million. Service contributed in the double digits at 11% of overall revenue, including software subscriptions.

We delivered non-GAAP gross margin of 65.5%, resulting in a non-GAAP earnings per share of $0.59, plus growing EPS excess of 40% year over year in our competitive and dynamic industry. We now have over 3,500 customers with our continued trend of 1 to 2 new customers per day.

This quarter we had a number of key highlights. Our progress with the HP partnership via demonstrations at VMworld 2015 of conferred solutions with HP Openview continues. We introduced next generation leaf switch platforms based on Broadcom's much anticipated Tomahawk Silicon for flexible 10, 25, 40, 50 and 100 gig ethernet switches with and hitless system upgrades capabilities. Our new products were endorsed by a number of our ecosystem partners at an NYC event we held on September 14, 2015. We do expect the next year to fuel the demand for 25, 50 and 100 gig ethernet upgrades.

We unveiled a strategic security architecture for cloud networking called macro segmentation services, or MSS for short. Our CloudVision MSS has been endorsed by many new and existing security leaders including VMware, Palo Alto Networks, F5, Checkpoint and Fortinet. MSS delivers improved risk litigation and compliance and enables a new, unified fire wall policy for both physical and virtual worlds, utilizing the rich programmability of Arista EOS.

Speaking of partners, we have strong supporters of open source community initiatives such as Microsoft's ACS and HP's OpenSwitch. Both are setting examples of the open source stack similar to what Facebook's FBOSS that was announced last year and they compliment our award winning EOS. In Q3 Tech Targets recognized us with an invasion award for Arista EOS.

This month, we formalized the technical advisory board at SMPTPE 2016, Society of Motion Picture and Television Engineers for media and entertainment with the participation of Fox and Imagine, amongst many important industry participants. We believe the migration from analogue broadcasting to digital IP is very important development for modern work stream.

As we witnessed the mega consolidation of large IT suppliers, many of my blogs and prior predictions ring true. New (technical difficulty) pioneers like Arista are leading the transformation from legacy and closed systems to the third wave of open cloud and converged platforms. Arista has been a thought leader of this throughout and follows a strategic imperative from customers to shift from siloed IT to universal and programmable clouds.

As we reflect on mid-year 2015 market data reports, Arista's evolution and leadership in market share has grown from single digit 7% in mid-2013 to double digit 12% in mid-2015, in the relevant 10, 40 and 100 gigabits data center switch port category. Clearly, we are out pacing the industry average growth. We feel poised to accomplish $1 billion run rate next year, a year earlier (technical difficulty) predicted.

In summary, I would like to say that I'm pleased with our (technical difficulty) our differentiated cloud efforts and a world class team to achieve this. It positions us uniquely in the year and the decade ahead.

Ita, I would now like to turn it over to you, our CFO, for Q3 2015 financial details.

Thanks, Jayshree. Good afternoon. The analysis of our Q3 results and our guidance for Q4 2015 is based on non-GAAP and excludes all non-cash stock-based compensation expenses, legal costs associated with the ongoing lawsuits and the release of a GAAP tax reserve as described below. Our reconciliation of our selected GAAP to non-GAAP results is provided in our earnings release.

Total GAAP revenues in Q3 were $217.5 million, up 40% year over year and comfortably above our guidance of $208 million to $212 million. We experienced good momentum in the quarter, with revenue contributions balanced across our key verticals. Service revenues continued to tick upward at 11.1% of revenue for the quarter.

International revenues came in at $47 million, or 22% of total revenue, down from 23% last quarter. We experienced continued growth in EMEA, offset by some lumpiness in APAC related to some large deals recorded last quarter. While we continue to focus on expanding our international footprint, you should expect our geographical revenue mix to fluctuate on a quarter-over-quarter basis depending on the typing of US and international deployments.

Overall gross margin in Q3 was 65.5%, down slightly from Q2 at 65.8%, and just above the upper end of our guidance range for the quarter. Operating expenses for the quarter came in at $83.1 million, up from $74.7 million last quarter. This increase in spending was largely related to increased personnel and prototype expenses for R&D.

We continued to grow our sales in marketing head count in the quarter, but these increased personnel costs were offset by some reductions in demo and other marketing expenses. Overall spending was 38% of revenue, consistent with last quarter, with expenses growing at the same rate as revenue and investments being funded by top-line growth. Our operating income for the quarter was $59.5 million, or 27.3% of revenue.

Other expenses for the quarter was $0.7 million and our effective tax rate was 27.3% resulting in net income for the quarter of $42.4 million, or 19.5%. Our diluted share number for the quarter 71.9 million, resulting in diluted earnings per share number of $0.59, up from $0.54 in the prior quarter and up 48% from the prior year. Legal expenses associated with the ongoing lawsuits came in at $15.9 million for the quarter, slightly above our outlook of $15 million on the last earnings call. As a reminder, these expenses are excluded from the non-GAAP results discussed above.

For those of you focusing on our GAAP results you will notice our effective tax rate on a GAAP basis came in at 6.1%, down from 26% last quarter. This reduced tax rate results from the release of GAAP tax reserves related to an uncertain tax position, for which the statute of limitations has now expired. We have excluded this effect from our non-GAAP results in keeping with our view that the non-GAAP numbers should present ongoing business trends.

Now turning to the balance sheet, cash, cash equivalents and investments ended the quarter at $568.6 million. We generated $10.6 million of cash from operations in the September quarter, down from $52.6 million in the prior period. The reduction in cash generated largely resulted from an increase in accounts receivable due to reduced collections in the period. This does not reflect any changes in overall credit metrics or business linearity but was directly related to some personnel and system changes during the quarter. We would expect this trend to reverse in the fourth quarter.

DSOs came in at 68 days, up from 57 last quarter. Inventory turns were 2.6 times, down slightly from 2.7 in Q2. Inventory increased to $110 million in the quarter, up from $100 million in the prior period. Raw materials increased by $11.5 million, reflecting growth and ship inventories in advance of ramping new products. This growth was offset by some reduction in finished goods.

Our deferred revenue balance was $191 million, up from $164 million in Q2. This balance continues to be 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 38 days, down from 59 days in Q2, reflecting the timing of inventory receipts and payments. Capital expenditures for the quarter were $5.2 million.

Now turning to our guidance and outlook for the fourth quarter, we are pleased with our year-to-date financial performance, with revenues up 44% and earnings per share up 62% on a year-over-year basis. We continue to increase our market share and gain traction across key verticals and customers. Based on current visibility, we expect our Titan vertical to contribute strongly to revenues in the December quarter. A meaningful mix towards these larger customers will likely result in gross margins at the lower end of our typical 63%, 65% range. Consistent with prior quarters, we will continue to leverage the growth of the business to fund investments and sales and marketing and R&D.

With this as backdrop, our guidance for the fourth 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 lawsuits, is as follows, revenues of approximately $238 million to $242 million, gross margins of approximately 62% to 65%, operating margin of approximately 26%. Our effective tax rate is expected to be 28% to 30%, with diluted shares of approximately 72.5 million. Please note that based on our current understanding, we expect the costs associated with the ongoing lawsuits to be approximately $10 million for the quarter, down from last quarter's peak of $15.9 million.

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

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

(Operator Instructions)

Our first question comes from the line of Mark Sue of RBC Capital Markets. Your line is open.

Good afternoon. If I look at your results in the pipeline, it seems the runway is still lengthening for you in terms of the opportunities. And in terms of how you are planning your growth related to the head count in opportunity and TEM expansion, are we at the point where we could see additional verticals being added to Arista?

Are we at the point where we could add more channels to Arista? Just how we could frame the outlook considering you are right around touching a run rate of $1 billion now. Thank you very much.

Hi, Mark. Thank you for the question. We don't see any dramatic change in our run rate. We're very pleased with what I classify as two categories of customers we're serving. One is the cloud customers, which is our top four verticals and the other is the converged customers. Through our partnerships we can handle a lot of verticals that are not mentioned in the top four but are still addressed through our partnerships with HP, VMware, and a number of others.

So the two thematic focuses are really cloud platforms, where our top four verticals is something we directly and intimately deal with and then converged platforms, where we work many times through technology partners, not just channel partners, and they address a number of verticals.

As I said in the call, one of the meaningful verticals for us that we look to address and today we largely group into high-tech enterprises, media and entertainment. We see that as a very important vertical that appreciates the performance, the software capabilities and the cloud characteristics are very similar, and they are handling a lot of performance and work streams. Our pipeline is very solid and we continue to focus beyond the four verticals, but the four verticals have a lot of penetration left in them.

Your next question comes from the line of Inder Singh of SunTrust. Your line is open.

Thanks for taking the question. Congratulations on a solid quarter. I wanted to just ask you about your operating margin performance, which has been outpacing some of the guidance you have been giving over the last few quarters, maybe more. It's been running 200 basis points or so higher than your guidance, yet you feel that there's some cautiousness or something that you are trying to factor into your guidance. Is there something that in particular that causes you to be cautious or is it just conservativism in terms of your guidance around operating margin?

Thank you, Inder. First of all, I would say that we want to make sure as a company, and this is our philosophy, I think I have shared it with you all many times, that we are peddle to the metal on R&D and leave no stone unturned in terms of innovation. We continue to allow or generous investment in R&D much higher than industry averages, as you know, and in terms of percentage of revenue.

We have not always been able to meet it, because we don't want to the reduce the caliber of our hiring, or often prototype expenses that we foresee in a given quarter slide out because the chips are not available so we are not going to waste money just because we want to spend money. Our R&D will continue to be high, in the 20%s, in percentage as function of revenue, but obviously as our revenue is growing fast we're not always spending as fast, but we plan to spend. We continue to want to invest there.

Sales and marketing, little bit different. As you know, we have had a very targeted sales and marketing focus. In fact, I will tell you that in terms of quality, we are putting a higher priority on this and flushing out the non-performers. Over there, our spending has been low, and below the targets we intended for two reasons. We want to keep the quality high, but also there we are leveraging a lot of our technology partners, so we want to plan for the spending but not necessarily spend for the heck of it and that's what you are seeing in the last few quarters. Ita, maybe you want to add something there.

The only thing I would add in there is some of that out-performance has obviously been coming from the gross margin line, as well, where we've been hitting the upper end of that range. I would say for this quarter, we provided some color in my script but I think we see, at least based on what we can see now, that there is a mix towards those larger customers this quarter, so I would expect the gross margin line to really come in line with the guidance just because we see that trend already.

Right. Good point.

Great. Thank you for the color.

Your next question comes from the line of Jeff Kvaal of Nomura. Your line is open.

Yes. Thank you very much for taking the question. I have a question about the broader outlook for some of your top verticals. I think some of your end customers, or some of their peers, have started to talk about being a little bit more careful with their CapEx spending over the course of the next few years.

Could you help us understand what you are seeing from the cloud titans in particular? In particular, I guess, it would be helpful if you would allow us to understand which applications are the ones that typically drive the most purchasing for you, whether it's search or video or advertising or public cloud or what have you? Thanks.

Okay. Thanks, Jeff. I'll try my best. First of all, the interest from the cloud titans has been very high and the growth has been unabated, and that's why we're forecasting a strong cloud titan quarter for Q4. We are in six out of seven cloud titans in the US and we continue to make some progress internationally, as well, and while not all six show up every quarter, and especially the last three quarters have been very balanced, we think we will see lumpiness in the direction of more cloud titan spending, if not less, the next few quarters.

So we're not seeing what the others are seeing. The acceptance of the cloud titans through Arista has been particularly consistent and strong. It varies by quarter. It's always lumpy and as Ita pointed out, if they buy too much it will affect the gross margin, but it's been healthy.

In terms of applications, they tend to be very dense computing, very large-scale out storage. They are definitely more geared to the public cloud. There are some hybrid cloud applications as well, but more on the public side than in the private.

Okay. Thank you very much.

Thanks, Jeff.

Our next question comes from the line of Michael Genovese of MKM Partners. Your line is open.

Could you talk about the importance of 25 and 50G? Is there any uplift in average selling price, perhaps, in the fourth-quarter guide or is it a 2016 event, to see 25 and 50?

Michael, I think all of the speed upgrades take longer to happen than when the products are available. The effect of 25 and 50, I'm going to forecast is more real in 2016 than Q4. We'll see some small (inaudible) but to put this in perspective, it's taken 10 years for 10 gig to become mainstream. I'm not predicting 25 and 50 years for 25 and 50 gig, but it does take time.

In terms of pricing, you do not see significant price upticks. You will see mild maybe, but most people expect higher performance for less ASP degradation, is the way to see it. Did that answer your question?

Yes. As long as -- if you haven't moved on yet, I will ask a follow-up. (Multiple speakers) The lawsuits, the three that you were -- going on in the last quarter?

Sorry? What was the question? We didn't understand it.

The question is about the lawsuits, if you could give us an update on the three cases that were in the courts last quarter and what's going on with them?

I am going to turn over to my expert general council, here. Marc, are you ready to answer that question?

Sure. I would be happy to answer. As you point out, we had several cases that went on last quarter. The first was in the ITC, we call it the 944 investigation. That trial was completed in September. Since one of the patents accused in that case was dropped, that means there are five patents that are remaining in that case that need to be decided upon.

We expect Judge Shaw to issue his initial determination on that case on January 27 of 2016. What happens next is that the ITC Commission then reviews that initial determination and issues a final determination on May 27 of 2016. That then goes to the US trade representative who makes a final decision on the case on July 27, 2016.

The second case in the ITC is the 945 investigation. That actually goes to trial on November 9, on Monday, lasting through November 20. Following that trial, the Administrative Law Judge, McNamara, is scheduled to issue her initial determination on that case on April 26 of 2016. That then goes to the full ITC Commission, who reviews the initial determination and issues their final determination on August 26 and then finally, the US trade representative makes the final decision on October 26 of next year. That's the status of each of the two ITC cases.

As a reminder, there is also the copyright case that is ongoing as well and that continues to be scheduled to August 2016 and we're currently in discovery in that case. Just to aid the investor community, we'll put up on our website, our investor website, a document that sets forth all the key dates of the trial, so you can refer to that if you need the specifics.

The last case that we worked on was the OptumSoft case. The first phase of that lawsuit, the trial occurred in September. There is no scheduled date for a decision by the judge but we would expect one probably within the next six weeks or so, towards the end of November, and we'll obviously be waiting on that. The second phase of that lawsuit is currently scheduled for April of 2016.

Thank you very much for allowing the questions.

Sure.

Our next question comes from the line of Vijay Bhagavath of Deutsche Bank. Your line is open.

I was on mute. Hello?

Hello. We can hear you now.

A quick question on DSOs, like to get any color on that. And then also on gross margins were slightly light versus expectation on your guidance. Was that mixed related or just (technical difficulty) aggressiveness into the cloud titans? Thanks.

I think the DSOs are really mechanical collections activities in the quarter. We had some turnover in the team, et cetera. I expect that to come right back in Q4 and in fact, we can see that happening already. There's nothing more there than just shear execution.

In terms of gross margin, I think for Q3 we were actually above the upper end of our guide and then in Q4, we are guiding to the lower end of that typical range and that is really all based around the mix of titans that we expect to see in the revenue in Q4.

Okay. Thank you.

Our next question comes from the line of Sanjiv Wadhwani of Stifel. Your line is open.

Thanks. One clarification and a question. On the clarification, any 10% customers in the quarter? The question I had was, Jayshree, when you look at 25 to 50 gig, understanding it's a 2016 event in terms of demand, is it mainly going to come from the cloud titans or do you see a lot of the financials and other verticals also picking up 25, 50 gig? Thanks.

Thanks, Sanjiv. First of all, there was no 10% concentration this quarter. As we said, we don't really reflect any concentration on a per quarter. We like to report that on the year but there was none, to answer your question directly.

In terms of 25, 50, the biggest uptick we do see, an interest we do see, is for storage and computer applications in the cloud. That is the primary application, but we don't preclude interest in many cloud-like enterprises and financial and web and service provider customers so we do see a sprinkling of interest across all four verticals but I would say the concentration of interest is coming from the cloud, to answer your question.

One common interest we see across all four verticals is the 100 gig. Everybody is looking for 100 gigs spine from Arista and Arista is very uniquely qualified in building the best spine platform.

Got it. One quick question on Microsoft, given that they haven't been a 10% customer for two quarters now. Do you expect it to be up this year compared to last year?

I've always projected that they will be flattish and as the year ends, we will definitely give any guidance and information on customer concentration.

Got it. Thank you.

Our next question comes from the line of Ryan Hutchinson of Guggenheim. Your line is open.

Great. Thanks. Congratulations on a nice quarter. Jayshree, my question is on guidance.

Suggest, obviously, no slowdowns, site with strong growth from the cloud titans. As we think about 2016, specifically Q1, should we take into consideration typical seasonality witnessed by other networking security and storage vendor, especially given the above consensus guidance that you gave this afternoon? The reason I ask is prior to this release, consensus estimates implied flattish to slightly up revenue entering the new year and I want to make sure we're appropriately modeling at Q1 at the right level.

Thanks, Ryan. I appreciate it. I think we have signaled a strong Q4 guidance. Obviously, Ita and I will talk about Q1 guidance in Q4. However, if you look at our last few years and history, we have always had a seasonally weak Q1 and we have generally tended to be flat to down, so I wouldn't read anything into it except when we have a strong Q4, we generally have a weaker Q1 and then we pick up the pace in Q2, Q3 and Q4. I think that's just good modeling for you.

Appreciate the color.

Thank you.

Our next question comes from the line of Alex Kurtz with Sterne CRT. Your line is open.

Thanks for taking the question, and a great quarter here. Jayshree, back on the litigation issues, how are you working with the sales organization to mitigate the impact on this around pipeline with existing customers and new customers and sort of how people are thinking about big purchases going into the first half of 2016, around this specific issue?

Thank you, Alex and thanks for your wishes. I've said this before and I'll say it emphatically again, the lawsuit has not had a dramatic negative impact on our sales momentum and customer revenue. That's because our customers are smart and they understand that while there's risks there's a deep appreciation for our technology advantages and also our commitment to assure continued supply through work arounds in a variety of ways.

The way we have addressed it is actually how we addressed it with you all. We explain the risks, we explain our advantages, we explain the possibilities of work arounds and get them comfortable.

Marc, I don't know if you want to add something. You've joined me on many of these customer calls.

No, I think that's right, Jayshree. I think the focus right now is to continue to defend ourselves in the case and to create a mitigation strategy in the event that there's a negative outcome.

Yes. Thank you.

Your next question comes from the line of Hendi Susanto of Gabelli & Company. Your line is open.

Good afternoon, Jayshree, Ita and Chuck, and thank you for taking my questions. I would like to clarify your expectation of strong cloud titan performance in Q4. Will that be concentrated in Q4 or will it be a moving per-quarter roll out? Additionally, what are some of the major applications that the cloud titans will be engaging in Q4?

Thanks, Hendi. I think I answered the cloud application question as best I could. A lot of focus on scale-out storage, compute and public cloudy deployments, largely leaf and spine with really dense computing, thousands of servers, terabytes of storage, et cetera. In terms of further guidance beyond Q4, the best I can say is we're confident of $1 billion run rate in 2016.

Thank you.

Thank you.

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

This is Victor Chu in for Simon. I wanted to ask about the VMware, HP and Dell partnerships that you mentioned before. Can you just give us more color around how that's progressing and maybe help us assess the prospects and timing for each and maybe I think it would be helpful if you could give us a sense of the ranking of them by significance?

I never like to pick favorites among my children, so don't make me do that. Definitely I would say our progress with HP and VMware is stronger than the others. Palo Alto I would say is the -- those three have been ones we've been working closely with and each of them have their unique nuances and technological advantages.

With VMware, we have six or seven levels of integration. Most people just focus on NSX and VX lan, but we're very partnered with them on their cloud initiatives, on their monitoring initiatives, on their efx and mainstream (inaudible) so our partnership with VMware continues to be very robust, especially as it relates to virtual to physical to cloud networking. More recently, we also introduced security initiatives with both VMware and Palo Alto.

In terms of HP, a real focus on conversion construction. We see a class of customers that want their compute, their storage and their network together and really bringing the best of breed components and this definitely includes Arista as the networking component and HP as the compute component and sometimes storage. That would be the two examples I would give you.

In terms of Dell, we have done work with them on CloudVision integration and ESM integration. Things have just gotten started over there so it's very early and time will tell.

Okay. The timing for the other ones?

I'm sorry? Timing for?

Timing for when the VMware, HP, et cetera might become more material?

Oh, more material? We started to see wins with both VMware and HP in 2015 and I believe we'll continue to see that in 2016 and 2017, so the timing has already begun.

Okay. Great. Thank you.

Our next question comes from the line of Paul Silverstein of Cowen and Company. Your line is open.

Hi. This is Fahad in for Paul. Can you provide some quantification as to the level of diversification amongst the top four verticals? What was the distribution across those verticals?

We don't tend to break it out, Fahad, but as I said, they were very balanced so you can assume all of them were double-digit percentages.

Okay. One question on the competitive front. As you introduced CloudVision and this micro-segmentation service, it appears you are increasingly getting into the NSX space or the VMware. How do you manage potential channel conflicts and do you envision any material -- as you move forward with your vision, those coming into conflict with your biggest channel partners?

Not at all. There's is absolutely no overlap in competition with VMware's micro-segmentation and Arista's MSS. Just to be clear, VMware's micro-segmentation is fine-grained security and fire wall policy at a virtual machine level. Arista doesn't do any of that.

That gets mapped into the V-switch and Arista picks up where they leave off and provides east-west security mitigation and risk compliance between the VM world and the fire wall policies that may be coming from Palo Alto or F5 or Fortinet or Checkpoint, so there's a lot of talk about security threats.

But even after you catch them you have to prevent them from spreading and that's really where Arista comes in. We're bridging the gap between NSX micro-segmentation and existing fire wall rules and policies, which tended to be more (inaudible) and have done some very deep integration with both NSX and Panorama from Palo Alto.

Thank you for the clarification.

Thank, Fahad.

Our next question comes from the line of John Lucia from JMP Securities. Your line is open.

Hey, guys. Thanks for taking my questions. Jayshree, you indicated Arista benefited from software subscriptions in the quarter. What was the makeup of those subscriptions? What services were those?

Can you talk about in general how you expect software subscriptions to trend as a percentage of revenue in the long term for Arista. And then I have a quick follow-up. How many sales people did you add in the quarter?

I'll take your second question first. We don't tend to give out specific numbers, so that's easy. I won't tell you. Thanks, John.

But on the software subscription, I think this is a longer-term vision and strategy that we're developing. This is well understood in the security world, but it's only just now forming in the cloud networking world and CloudVision is clearly our first example of that. The uptick you are seeing, obviously we're getting strength and -- strong acceptance of CloudVision both in terms of customers and bookings, but by the time we realized this into revenue and billings, we'll have a delayed factor because they are long-term subscriptions.

I expect in the long term, long term envisioned by one to three years, for CloudVision and software subscriptions to be a greater component. Until then I think we'll be in the 10% to 12%. But this could give us a reason to get into the teens in the future.

You said until then you would be 10% to 12%. Is that like in a year you would be 10% to 12% or is that the next couple of quarters?

10% to 12% of total revenue. As we said (multiple speakers) right, including services, so services and software subscription (multiple speakers) hover in the 10% to 12% range of total revenue.

Okay. Thank you.

Thank you, John.

Our next question comes from Kulbinder Garcha of Credit Suisse. Your line is open.

Thank you for the question. Just two. One of them is basically on the issue of work arounds for the ongoing litigation. Where are we in the process and how are you guys managing that, basically? Because I guess you have to be informed in terms of what kind of work around you need and then how you are going to communicate to your customers and what's the timeline. Anything on that would be helpful.

And the second is probably a little bit easier. On gross margins, maybe this is for Jayshree, Arista executed very well versus -- you have always flagged that gross margins might trickle down, there would be this mix shift towards the cloud a little bit in some quarters. You executed well against that.

We've seen a slight decline now over the last year and a bit. What are the positive drivers in gross margin that you are implementing to offset that over the longer term? If your cloud business is very significant, there should be some positive initiatives in place. The software and services seems like a very -- software seemed like a very long term issue, but is anything in next year, whether it's a product refresher or other things on the positive side we should think about? Thanks.

That's two questions. The first one, on work-around, as you can imagine, we are putting in place contingencies for the work arounds. There's a very strong engineering focus. Marc, do you want to add to the work-around piece?

Sure. To Jayshree's point, we have actually developed, to greater or lesser degrees, design arounds for each of the patents in the event that there's an adverse outcome. Some have been implemented already; others are in the process of being implemented and frankly, a big part of the litigation process, of course, is to understand the nature of the claims that are being asserted and so it's a moving thing as we see how theses are litigated. I would expect significant effort in the first half of next year.

Right. Thank you, Marc. On gross margin, as Ita has often said, if we have a lot of cloud titan spend, then are gross margins are 60% to 65%, we'll tend to favor, less 65% and more in the early 60%s. If we get the mix right, then that's why you have seen us do so well because the last three quarters have been very balanced quarters.

Clearly, while the software and services will contribute in the longer term, we also have a third component, which is product mix. We will continue to do aggressive cost reductions and the increase of 100 gig into our mix will improve our margins as well. For all those reasons, I think we'll always be in that 60% to 65% range, trying hard to be more in the 62% to 65% in the near term, rather than less than that and we feel comfortable that we've got enough levers to do that.

Thank you.

Thank you, Kulbinder.

Your next question comes from the line of James Faucette of Morgan Stanley.

I wanted to ask a follow-up question on the benefits of the 25 and 100G products in 2016. Should we expect that they will grow kind of in line with the natural growth rate that you have been seeing that has to do with growth in addressable market plus your share gains, or is there an opportunity or how much of an opportunity is there for incremental acceleration on the back of replacing existing parts to the deployed base?

Thanks, James. It's difficult to predict the port mix of what will grow faster and what won't, because it's customer dependent. But maybe I step back and share with you some of the [Deloro and Cream] data. What is clear is 10 gig will be more steady. 40 gig may actually come down over time. I don't know if it's exactly 2016 but if I look in three years, 40 gig's projected to come down.

25, 50 and definitely 100 gig are the high-growth areas. The mix of all of that we absolutely predict will be double-digit growth for us in the foreseeable future.

We're less hung up on port mix. We look at this as high performance ports. In fact, sometimes we don't even know how our customer might break a of port. They may take a 40 gig and break it out into four 10s, and the same thing with 100. They may break it out into two 50s or 10 10s or whatever.

I think take away from this is the common denominator is increments of 10 gig ethernet and one thing we're definitely seeing in especially our four verticals, is the need for 100 gig spine as a common denominator. Whether the host connects to 1 or 10 or 25 or 50 seems to depend on the use case and applications. Thank you, James.

Our next question comes from the line of Simona Jankowski of Goldman Sachs. Your line is open.

Hi. Thanks very much. I had a couple of questions on 25 and 50 gig, as well. I guess the first one is, it looks like there's going to be maybe five or so vendors with products in that category so just wanted to see how you view the competitive landscape there versus what you have been dealing with so far.

And then as far as pricing is concerned, on a per gig basis, it looks like one of the big advantages is that you are going to be able to get much, much lower price per gig. How do you think about that from an overall revenue and margin perspective?

And then just lastly, would you expect any customers to pause and wait for these products or do you think 40 and 100 gig is going to go -- is going to continue to see high demand right up until these products become available?

Thanks, Simona. There's actually three questions there, so I'll do my best to address 1A, 1B, 1C, right? 1A, 25 and 50 gigs, there's always been five vendors for us in every performance metric. I don't think it's unique to 25 gig. Of all the competitors, we have the largest monopoly is obviously Cisco and then, as is often referred to in our industry, there's Cisco and many dwarfs. Obviously, Arista is clearly now identified as the clear alternative in the data center. We see that playing out for all the other performance metrics, as well. We don't see anything unique.

Some of the stand-outs for us is our high availability architecture, our highly programmable software, our ability to do SSU and hitless upgrade, our ability to really deliver features at fierce velocity, not compromising the rapid use of merchant silicon. Everybody has access to the same silicon, but we develop a much better and much more technical superior product and many times command a price premium for that.

To come to your second question on price per port, we have seen ASP stabilize in the 10 gig and we do see that 25, 50 and 100 gig ASPs will depend greatly on volume, just like they did on 10, and also a real opportunity and issue is the optics, the interest connect optics for these 100 gig, right?

So we see that those often can be more expensive than the port itself, so stay tuned for Arista to really offer some important alternatives, both embedded, integrated and different type of transit options. I think price per port, especially taking into consideration the interest-connects between these ports, you will see some ASP fluctuation, but even improvements. I have forgotten your third question.

If you might see any kind of pause in demand as customers are waiting for these.

At the moment, it's hard to tell that we see any pause. The publicity on, for example, Tomahawk silicon and 25, 50 gig has been going on for a year and that has caused us no pause. I think our customers expect these speed transitions. If anything it validates ethernet as the foundation for all networking connectivity, and they'll use what we have now and wait for what we have in the next quarter. Especially in our top four verticals, I've rarely seen them just pause if they need to absorb technology and keep their networks running.

Great. Thank you, Jayshree.

Thank you, Simona.

Your next question comes from the line of Jess Lubert of Wells Fargo Securities. Your line is open.

Hi, guys. Thanks for taking my question and congrats on another strong quarter. I also wanted to ask two questions. First, I was hoping you could talk a little bit about the outlook internationally and what degree you believe the safe harbor ruling may cause some of your US cloud titan customers to accelerate international data center deployments in 2016 and beyond, to what degree you have the infrastructure in place to capture that opportunity.

And then second, our research suggests Arista may be getting close to launching a DWDM line card to directly address the data center interconnect market. I was hoping to better understand the opportunity you see there and what the margin implications might be for such a solution.

Okay, Jess. Thank you. Thank you for your wishes. Regarding the cloud infrastructure, I think you bring up a very good point. In particular, some of the major cloud titans, not all, but certainly the major ones we're working with, all have international presence and Arista has put in an infrastructure, Ita and Marc, I would say much of last year and this year, so we're pretty ready for this. We've been handling this for some time now. We're coming on two years where we've been pretty prepared for this.

Our top cloud titans tend to order at the point of location and that's something we're very comfortable with and we have station depots and support capabilities everywhere. In fact, I would say to you, with the exception of maybe China, that we have not seen that same type of cloud titans in other international locations and we look to grow them more perhaps to service providers internationally who may become cloud providers as well. We believe strongly that we have the infrastructure for it. Ita, do you want to add anything more to that?

No. I think clearly we've been focused very much particularly starting with Europe and then in APAC and adding infrastructure in advance of growing the revenues, so we're well set up to be able to take any acceleration of business that comes about from that.

Just to put this in perspective for you, Marc just shared some data with me. We're in 68 countries today with over 40 service depots.

Do you see some of those rulings accelerating the activity over there?

Do I see some of them accelerating and growing? To be honest, they don't give us the vision and longevity of that to tell you beyond a few quarters. I can see it, but it's difficult to predict precisely til they tell me.

And then on the DWDM line card for data center interconnect?

Yes. You did ask a question on a future product. We'll comment on that when we introduce it. How about that?

Okay. Can we at least assume that the margins will be consistent with the corporate average if you do introduce something along those lines?

Yes, I don't think we're ready to comment on that yet. Let's get the product out and then we'll obviously update you on how it fits into the model when we do that.

Okay. Thanks.

Thanks, Jess.

Our next question comes from the line of Rajesh Ghai of Macquarie. Your line is open.

I'll add my congratulations. I wanted to refer the question that's been asked before on this call. It's really to address a concern that I hear about cloud titans and all of them launching their own switches and their own light box switches. What percentage of the data center networking spend are the cloud titan (inaudible) target? In other words, how much of the spend requires the performance of latency (inaudible) switches and how much of the spend could be targeted using light boxes?

Thank you, Rajesh. That's a good question. I'll share with you some of the public data and then obviously whatever's confidential, I can't. If you look at some of the major cloud titans like Google or Amazon, I'd pick as two examples, they have a precedence of building their own switches long before Arista was even founded or came into the picture.

Even when cloud titans invest in their own switches, they complement this with Arista product, for a very good reason. Generally, the good reason is they build their own to get economies of scale for single use cases but they use Arista's to get the programmability and scale out particularly in the spine or spline categories.

We do complement each other and we also have a habit of working with them on switches they have. We worked very closely with FBOSS and we intend to work fully closely with Microsoft ACF initiatives or other cloud titans as they present themselves. We don't look at them as threats. We look at them as opportunities to work with them to make them better.

Thank you.

Thank you, Rajesh.

Your next question comes from the line of Alyssa Johnson from Pacific Crest Securities. Your line is open.

Hi. Can you remind me, was there a certain vertical that's kind of driving your expectations for a strong Q4?

Yes. I think Ita mentioned it, Alyssa, and that would be the cloud titans.

Okay. Thank you.

Thank you.

Our next question comes from the line George Notter of Jefferies. Your line is open.

Hi, guys. Thanks very much. I wanted to go back to the international side of the business. I think if I look at the numbers, in absolute trends your international business has been pretty consistent for the last three or so quarters. I guess I'm looking for more evidence of traction there. I'm wondering if you could give us the number of VARs or distributors that you guys now are selling through internationally, the number of salespeople, maybe if you exclude the cloud titans, and you normalize those international numbers, is the balance of the business growing? I'm just looking for evidence of more and more progress. Thanks.

George, great question. We have legal entities in 18 countries. We have VARs, our VARs have increased from almost double to about 62 channel partners and these are selective partners. We don't go sign every Tom, Dick and Harry, right?

We do have presence in, as I have often shared with you, the developed countries. We have not put as much focus on the emerging countries.

In the absence of cloud it to titans internationally, I think we are doing very well. We don't talk about breakdown in sales people but we are in 62 countries with the 60-plus channel partners we have, so this is also an important factor. I can tell you, we're hiring disproportionately internationally from a sales point of view than we are in the US, relative to the contribution. We are investing ahead of revenue internationally.

Got it.

Hopefully those are good statistics for you to extrapolate. I said this before and I'll say it again, George, I think the success of US is really hiding the success internationally.

Got it. Was the international business up sequentially, X the cloud titans?

Yes.

Great.

This concludes the Arista Q3 2015 earnings call. I also want to mention that we have posted a presentation which provides additional perspective on our Q3 2015 fiscal results, which you can access on the investors section of our website. As well as our General Council, Marc Taxay, mentioned, we will be posting shortly after the call a summary of the key dates in the legal proceedings.

Finally, thank you to everyone for joining us today.

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