Arista Networks Inc (ANET) 2016 Q3 法說會逐字稿

Welcome to the third-quarter 2016 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 September 30, 2016. 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 FY16, industry innovation, our market opportunity, and the impact of litigation, which are subject to the risks and uncertainties that we discussed 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 on our third-quarter 2016 earnings call.

I am pleased to report that we had another record quarter. Our revenue exceeded the consensus, as we grew 33.4% year over year to $290.3 million, while our non-GAAP earnings per share grew to a record $0.83.

Our new products, the 7500R and 7280R Series, as well as our highly differentiated EOS platforms, fueled our growth across our top verticals. Services contributed over 12% of our overall sales.

From a geographic perspective, our customers in the Americas contributed 82% of our total revenue, while our international theaters progressed steadily in the quarter. We delivered non-GAAP gross margins of 64.6% in a highly dynamic and competitive industry.

In terms of market trends, we have now acquired over 4,100 aggregate customers and have crossed 10 million ports in cumulative shipments since 2008. We are enthusiastic about our market adoption, as we increased our market share in the first half of 2016 to 14.9% in 10/40/100 gigabit ethernet high-performance ports, according to Crehan Market Research.

In terms of Q3 highlights, Arista unveiled its next-generation telemetry based on EOS and CloudVision. The Arista Telemetry Tracers leverage open-source solutions such as HBase, and standards such as OpenConfig, to capture, stream, store, classify, and view real-time actions. Just about every modern customer and architect is looking for analytical methods to efficiently and consistently gain visibility into millions of devices, data, and events. Arista's EOS streams the state of network events instantaneously for that real-time visibility into thousands of entities into a cloud network.

In September of 2016, HP Enterprise reinforced its strategic partnership with Arista as the preferred networking vendor at its worldwide channel partner event. We believe this is an important step in the relationship we started a year ago.

As we enter the final quarter of 2016, I am quite pleased with our execution in cloud networking. It has been a multi-year journey requiring the strong dedication and hard work by our employees and leaders alike. One executive who leads by example in the Arista way is Anshul Sadana. Effective October 2016, Anshul has been promoted to Chief Customer Officer responsible for all customer-related functions, including worldwide sales, product management, market development, systems engineering, proof of concept, and customer advocacy. Many of you may have interacted with him in the investor community, and I'm sure you join me in extending our warm wishes and congratulations.

Arista's vision and new products are resonating, and they are being actively deployed by our customers. In particular, the Arista Universal Spine and Leaf R-Series products have ramped nicely and we expect this momentum to continue into 2017.

Arista is clearly in the midst of a tornado cloud market. This increased demand has, however, created some challenges in our supply side as we are working diligently to address component shortages and ramp our new San Jose, US-based contract manufacturing facility. I could not be more excited by our customer acceptance of our software-driven cloud networking, and deeply appreciate our customers' patience with us as we improve the predictability of our shipments. Now, I will turn it over to Ita for quarterly financials and specifics. Ita?

Thanks, Jayshree, and good afternoon. This analysis of our Q3 results and our guidance for Q4 2016 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. A full reconciliation of our selected GAAP to non-GAAP results is provided in our earnings release.

Total GAAP revenues in Q3 were $290.3 million, up 33% year over year and above our guidance of $279 million to $285 million. Overall, the demand in the quarter was strong, not only from our cloud titan customers but also across our other key verticals. Service revenues grew with the Business, representing 12.4% of revenue, consistent with last quarter.

International revenues came in at $53 million or 18% of total revenue, down from 25% last quarter. The reduction in international revenues largely reflects the timing of overseas deployments by our global customers. These deployments tend to be somewhat lumpy and can be significant relative to the overall size of the business in those regions. We remain focused on expanding our international footprint, but you should expect our geographical revenue mix to fluctuate on a quarter-over-quarter basis depending on the timing of US and international deployments.

Overall gross margin in Q3 was 64.6%, up from last quarter at 64.1%, and favorable to the mid-point of our guidance of 62% to 65%. This reflected a somewhat more balanced revenue mix across our key verticals, offset by some additional overhead costs associated with ramping our US contract manufacturer and supply chain.

Operating expenses for the quarter came in at $100 million, up 3% from last quarter. R&D spending returned to a more typical 21.6% of revenue, down from 22.9% last quarter, reflecting some reduction in prototype spending. Sales and marketing expense was consistent at approximately 10.1%, down slightly from last quarter. Our operating income for the quarter was $87.2 million or 30% of revenue.

Other expense for the quarter was $0.1 million, and our effective tax rate was 29.7%, resulting in net income for the quarter of $61.2 million or 21%. The increase in the non-GAAP effective tax rate was primarily related to the shift in geographical revenue mix for the quarter. Our diluted share number for the quarter was 73.5 million, resulting in diluted earnings-per-share number of $0.83, up 41% from the prior year.

Legal expenses associated with the ongoing lawsuits came in at $9 million for the quarter, below our outlook of $11 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 that our effective tax rate on a GAAP basis came in at 18.5%, down from 26.4% last quarter. This reduced rate benefits from the release of some GAAP tax reserves related to an uncertain tax position for which the statute of limitations has now expired. We've excluded this effect from our non-GAAP results, in keeping with our view that the non-GAAP numbers should represent ongoing business trends.

Now turning to the balance sheet, cash, cash equivalents, and investments ended the quarter at $800 million. We used $47.3 million of cash from operations in the September quarter, primarily due to incremental investments in working capital, as outlined below.

DSOs came in at 67 days, up from 50 days in Q2. This increase primarily reflects the healthy increase in deferred revenues and some shift in linearity in the period. Inventory turns were 2.7 times, down from 3.5 in Q2.

Inventory increased to $162.1 million in the quarter, up from $118.1 million in the prior period. This is in line with our outlook on the last call for an overall incremental investment in supply chain-related working capital of approximately $100 million. $44 million of this increase is reflected here in the form of finished goods inventory, with a further $62 million as inventory deposits recorded in other assets.

Our deferred revenue balance was $284.8 million, up from $230.3 million in Q2. This balance continues to be made up of short- and long-term service contracts, and product-related deferrals associated with acceptance terms and future deliverables. Accounts payable days were 68 days, up from 56 days in Q2, reflecting the timing of inventory receipts and payments. Capital expenditures for the quarter were $3.7 million.

Now turning to our outlook for the fourth quarter and beyond, we are pleased with our year-to-date financial performance, with revenues and earnings per share up more than 35% on a year-over-year basis. As we look forward, the demand drivers of the Business remain strong, with healthy adoption of our new products across all verticals.

We continue to ramp our new contract manufacturer, working to increase volumes on a week-by-week basis. We shift meaningful revenue from this plant in Q3, and expect to see this contribution increase significantly in the fourth quarter. As previously indicated, we believe gross margins may be negatively impacted by these activities in coming quarters and could range from 60% to 65% depending on how heavily weighted our revenue mix is towards products manufactured in our new US facility and its associated supply chain.

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 $310 million to $320 million; gross margin of approximately 61% to 64%; operating margin of approximately 26%. Our effective tax rate is expected to be approximately 29%, with diluted shares of approximately 74 million. Please note that based on our current understanding, we expect costs associated with the ongoing lawsuits to be approximately $12 million for the quarter. At this time, we would like to open the call up for questions. Operator?

(Operator Instructions)

Stanley Kovler, Citi Research.

Yes, thank you very much for taking my question. I just wanted to get a better handle on the gross margin trends if we back into the trends to Q4 it seems like you are at about 62.5%-ish and previously I thought the outlook into that quarter would be towards the lower end of the 60% to 65% range. If we can just get some clarity on what you have done to close the GAAP there and then I have a follow-up. Thank you.

I think the way to think about it, Stanley, is that we had talked about the 60% to 65% range as a range over time and the lower end of that range was always going to be in a situation where we were not only manufacturing and shipping from the US contract manufacturer. But also heavily reliant on the supply chain in the US and that was something that's going to happen over time. But I think being in the midpoint of that range -- that original range in Q4, that's indicative of the fact that we are shipping a lot of product manufactured in the US and the [CM], leveraging some supply chain but we are still also leveraging prior age and supply chain product as well.

Thanks and if I can just ask about the supply constraints that were referenced on the prior call and if the sources are correct throughout the quarter the supply chain constraints sort of continued. How should we think about that into Q4 and essentially into Q1? When do you expect that to alleviate?

Can you help us understand at least in some of the product families what's been going on, more specifically as far as those supply constraints go. Because I think they are affecting the end customers differently.

If I could just squeeze in a quick question on Europe and international. Help us understand the disparity in the trends that you are seeing, potentially more strength in the US then International markets and how we should think about that. Thank you very much.

Okay, I will take a bit of that question, Stan. Basically you should think of our lead times as having gotten worse between Q2 and Q3. But we have every intention to recover in Q4 and Q1.

Our component shortages were across the board. They were on our switches, they were on our new products, they were on our cables, they were on our optics. There were shortages in 100 gig.

So while we have been working very closely with vendors to improve all of them, component shortages definitely played in, combined with the fact that we had unforecasted demand, so that combination definitely did not help. On the other hand I think we've got our VP of Manufacturing and Ita and the whole team has been working very hard. I am very comfortable that our vendors are working closely with us and this will improve in Q4 and get better by Q1.

In terms of International trends I think Ita already covered this. Basically it fluctuates and it is volatile. It is a strong function of not just our organic International performance which is doing well, but really our Cloud Titans and how they expand globally or don't.

So they expanded globally very well in our Q2. They did more United States in Q3 and that is reflected in the numbers. But what I would like you to take away is our international [theater's] organic growth is just fine.

Thank you.

Eric Suppiger, JMP Securities.

Yes, thanks. On the constraints. What did the lead times do in the third quarter and what can you get them down to in Q4?

If you recall, Erik, I shared with you all that the lead times in Q2 were in the range of four to 10 weeks which was already creeping up. We like it to be two to eight weeks and 10 weeks is on the high side. I would say in general it shifted by 20%, 25% higher in Q3.

So it's probably more like six to 12 weeks in Q3. We are looking to definitely bring it down depending on the product. Some of them will come down in Q4 but we expect all of them will that will recover nicely in Q1.

You said that it was that combined with unforecasted demand, what does that mean? Was there areas that you thought you did not anticipate demand that you saw or what did you see -- what did you mean by that?

I think we did not forecast accurately and forecast is a strong function of two things, right. There's the numbers themselves and then there's the mix and in both cases we under forecasted.

Okay. So will Q4 be benefiting from a fair amount of business lifting from Q3 because of the constraints? Is that how we can interpret the Q4 outlook?

I think the way to look at Q4 is -- and in fact as you noticed Ita gave a wider range. We have on one hand I think we will release some of the component shortages, on the other hand we won't recover entirely in terms of lead times because many of the components have much longer lead times than our products do. If you may recall I shared with you that some of them have 16 to 22 week lead times.

So while we will recover on some components, we won't recover on all products and all components. So this will be a multi quarter process. It will take us Q4 and Q1 to cover.

That's not necessarily just a function of you moving your manufacturing, is it?

That's the component shortage. That combined with the fact that Q4 is our full first quarter of US manufacturing is why we've got a lot of execution ahead of us.

But at the same time Erik, we are shipping record quarters but we are seeing incremental shipments and incremental demand. Obviously we are responding to those as fast as we can while we are bringing up the US manufacturing. So that's definitely a factor but there's also the fact that we are shipping volumes now we've been growing 30%, in excess of 30% year-over-year although the year so that volume is growing as well at the same time. So it is a combination of both.

Very good. Thank you.

James Faucette, Morgan Stanley.

Good afternoon. I just want to follow-up on the shortages question and I'm just wondering how confident are you right now that you are being able to scrub your orders and forecasts to take into account potentially any double ordering? How much double ordering do you think is taking place, I guess is a more direct way to ask?

Thanks, James. We are very confident that there is very little or no double ordering because our customer intimacy is very high. This is not just happening at the channels. We know every single order, these are new products that we are working closely with on their migration so we are comfortable that the customer is ordering for their demand and we are fulfilling for that.

Great. And then turning to the HPE relationship. Can you talk a little bit about how you expect that to develop? I know maybe from what it was to how you would envision that operating going forward.

I guess a small accounting question associated that. Will there be any channel fill or other changes in the way that you ship and recognize associated with the HPE relationship. Thanks a lot.

Thank you, James. First of all, I think I speak on behalf of Anshul, Mark Smith, Ita, myself, everyone, that they are all very excited about the HP Enterprise relationship. It's not a brand new one for us.

We have had a chance to date and get to know each other this last year really well. From Meg Whitman to Antonio, all the way at the top what we are seeing is that there are a number of partnership possibilities. We started out with the converge infrastructure and that's clearly one that Arista has not been participating alone on.

You have heard me talk about the three markets: the cloud scale, which is our Titans, the cloud class which is our four verticals, and then cloud converged. The cloud converged is a very natural synergy with HPE and especially with their compute and storage platforms so with HP's reinforcement that's really going to help. In a tier of enterprise that Arista has not typically been in.

The second thing I would say is I think HP's realization and partnership that we are the preferred vendor on the data center side and obviously they have a great deal of depth in assets on the Aruba and Campus side, makes it very complementary. We see a lot of excitement.

The agreement itself is actually officially getting signed next week, November 7. So right now we have the enthusiasm and we look forward in 2017 to convert that into real partnership and real wins.

James, it does not drive any different accounting on our side.

Jeff Kvaal, Nomura. Jeff Kvaal your line is open. You may be on mute.

Paul Silverstein, Cowen.

Thanks, a couple quick ones if I may. Jayshree, can you give us any update on the Cloud Titan's hyperscale as a percent of revenue or their growth relative to the rest of the customer base? Also, any more granular insight you can offer on the 7500R and the 7280R platforms in terms of the uptake either from a customer quantification standpoint where I trust the revenue contribution is still small but anything that would speak to the way there, the ramp?

And I hate to ask yet again on the component tightness but what it be possible to quantify -- have you quantified the impacts on Q3 as well as how much more revenue you think you would've been able to do in Q4 but the component tightness?

Okay. Three part question. Hi, Paul, thank you.

So on the Cloud Titans they continue to be very strong for us and the mix is very similar to prior quarters and important for you to understand it isn't one Cloud Titan but many of them. So we are quite pleased with their acceptance of our products and our relationship with them but no change in momentum and mix. It still very strong and growing well.

Jayshree, is it still around 25% of revenue or is it greater than that?

I have never mentioned percentages but as you know so I won't comment on agreeing or disagreeing with that but I will tell you it is as good as it was in the prior quarters. So going back to the R question which is our new products.

As I told you guys I was expecting single-digit customers in Q2 which was the first real quarter of shipment for our brand new products. What's nice is I think we've doubled from Q2 to Q3 in the number of customers in the routing. I'm still going to challenge the team to do 100 customers in a year so by next Q2 I would like to be at 100 customers in routing.

But both the 7500 and 7280R as new products is ramping very well, very, very well. Very rapid qualification and ramp both as a switch and in terms of routing. Again I think we're hitting our targets and exceeding them.

What was your last question? You last question was quantify (multiple speakers).

I will tell you we are working very closely with customers. We obviously had we had record ship quarter in the quarter and really this is more we are facing a lot of activity and we are working with customers to figure out how to slot in their demand. So it's very difficult to say okay was there something that removed from one quarter to the to the other. It is more, there is good strong activity and we are working with customers to figure out how to fulfill that.

(Multiple speakers) -- go ahead.

No, go ahead, Jayshree.

Paul I was going to add to Ita, that one of the things we are doing is it is not we ship or we don't ship. A lot of times we work with a customer to figure out what is their priority and ship partials as well. So some of them don't get shipped in one quarter.

But clearly there was some revenue, clearly revenue would have been greater I assume for Q3 as well as for Q4 but for the component tightness and if I may while I am at it, any change in the pricing environment?

In terms of clearly revenue would be greater. I am not one to speculate on the past. I'm going to focus on the present and the future -- don't know, Paul.

But what was your question, pricing? No, we didn't feel any different pricing pressures than we always do. In our market the pricing pressure by definition is high and it continues to be competitive -- but nothing unique in Q3.

Great, thank you.

Thanks, Paul.

Hendi Susanto with Gabelli and Company.

Good afternoon, Jayshree, Ita and Chuck. First, congrats on your achievement on winning almost 15% market share.

Thank you, Hendi.

Jayshree, I think you alluded to this, would you be able to quantify some estimate of the impact of the component shortage to yourselves. I don't know whether you are willing to share that or not. If not, one additional question is do component shortages occur more in the United States versus International markets since you (technical difficulty) -- [are wrapping up Corey US facility]?

No, so answer the second question, I'm not able to quantify any more (technical difficulty) -- [them sharing with you which is our lead times] moved and our shortages are not unique to one product. They were across the board.

But, no they did not just apply to the United States. In Q3 we were shipping with standard contract manufacturing -- (technical difficulty) until our borders closed til August 23. So on almost have the quarter we had the flexibility of all our contract manufacturers, right.

So our component shortages were tied to all our contract manufacturers. They were not unique to International only.

Thank you.

Thank you.

Jess Lubert, Wells Fargo Securities.

Hi, guys. Congrats on another nice quarter.

A couple questions as well, just first on the 7000 products I was hoping you could maybe provide a little bit more color with respect to interest you are seeing on the routing side. If it is beyond the cloud progressing over the next few quarters and to what degree? Jericho or incremental software features are the gating factors at the moment.

Then on the inventory side it didn't increase sequentially as much is I would have expected, so I guess I was hoping you could comment to what degree you feel you can meet your needs this quarter with internationally source supply. Do you think you need to leverage the US supply chain more heavily? If we don't hear something from US customs by the end of this quarter, to what extent are there ways for you to get components that are not manufactured in the US?

Maybe I will take that first. Inventory we had said we grow inventory working capital total around this for about $100 million. If you look at what we actually did, we grew inventory for $40 million-plus and then we grew component inventory, so showing up differently in the financials by a further $60 million-plus. So we achieved about $107 million of incremental finished goods and component inventory in quarter. It was pretty much in line with what we had planned to do, right.

We've always -- as you look at what's been happening, we've been executing pretty well to the plan. All right. We saw the contract manufacturer contribute meaningful revenue in Q3 and they are ramping in Q4.

So I think more and more of the volume will come from the US plant in Q4 and that's always been part of the plan. As we go beyond that we still have components that we will consume and then we have plans for what happens beyond that. We will execute on those as we go but really there is nothing happening that's different from what we expected and what was in line with our original plans.

It is fair to assume that you can get components that are not necessarily directly manufactured in the US through a third-party or some other source?

I'm not going to try to go component by component of what those plans are but we have been thinking about this for a long time and we've laid out plans for the various components and needs.

To answer your question, Jess on the routing. I am pleasantly surprised by the acceptance of our routing platform is faster than I expected. I don't think there will be material revenue until next year and year after, but as you know Arista's target is not the legacy router kind of customers that deploy SONET/SDH or traffic engineering and incumbency.

Most of those service providers and enterprise customers are transforming from traffic engineering to a more cloud like data center interconnect and [lease fine] architecture with software based automation routing and telemetry. So our customer count is increasing and it is going beyond the classical cloud Titans. As I said we've gone from single-digit customer acquisition and routing in Q2 to double-digit in Q3 and I think we will continue to see more customers in Q4, Q1 in 2017.

Thanks, guys.

Alex Kurtz, Pacific Crest Securities.

Yes, thanks for taking the question and congrats on the really strong execution here, Jayshree. Just to clarify in Q4 around the US manufacturing, is it a good assumption that most of your US customers will be supplied from US manufacturing this quarter or is there still some International products and inventory that can be used?

There some mix there but we are weighing more heavily towards the US manufacturing in Q4.

I think it is a good assumption that the majority of our supply will come from US manufacturing.

Okay and my last question, Jayshree, inside your top accounts, how are you -- assuming that the lead times stay where they are that you saw in Q3, how do you prioritize across different accounts and within accounts to make sure that you don't lose market share with really critical customers? How are you making those decisions right now or maybe those decisions that you have had [to made] have not really materialized yet. If you could comment on where you are making your bets with the inventory.

Actually thank you for that question and thank you for the good wishes. I feel like my CEO title right now stands for chief expedite officer so I'm prioritizing all my top customers very, very highly and it ain't easy when you don't have the parts to give all of them all they want.

But I think because of the nature of the relationship my team and I have with these customers they have put themselves in our shoes and feel our pain and we feel their's and we are doing the best we can to A, prioritize based on the mission criticality of their project, B, prioritize based on when they put in the order, so first in first out is a fair mechanism from our perspective. And as I said earlier, also where we cannot prioritize and ship everything we worked with them on partials. Those are the three primary mechanisms Thanks, Alex.

Mark Moskowitz, Barclays.

Yes. Thank you. Good afternoon. A couple of questions if I could.

I want to understand more about the terms of the growth factors you are seeing within cloud in terms of public cloud versus private cloud. [This mix comes to mind] come across in our research related to public cloud versus private cloud adoption. What private cloud adoption seems to be contents and air pockets. Are you seeing that in your business?

Then the second question is around routing. Follow up on some prior questions. Can you talk about how we should think about the longer-term sales motion there? Is there going to be greater R&D required, sales and marketing required as you begin to penetrate more sophisticated telco providers with their newer rollouts?

Let me take the two questions. First public versus private. I think there's no doubt in anybody's mind that the public cloud has already arrived. We are seeing a lot of workloads moving there and just to put this in context even two years ago there wasn't as much scale and expansion in the public cloud as there is today. Just about every major Cloud Titan is making investments in that, the seven [we state] and others.

In terms of public cloud, the one other thing I would want to say is there is the cloud Titans but there's a number of companies we are working with that I would say are not quite the scale of the Titans but are also building public clouds. They are very, very promising and we are working closely with them and there may be an instance of hybrid cloud or public cloud but I see a whole other tier, a second tier of cloud providers who are so promising some of them may will make it into the Titans in the next year or two.

That's another thing to consider that the workloads are moving rapidly and our product and our capabilities are beginning to become interested not just with the top Titans but the next tier as well. In terms of private cloud this is an area we've been focusing on with our other verticals (technical difficulties) [especially] high tech enterprise and financials. What I would tell you there is they very much emulate the practices of the public cloud but obviously the scale of it is much, much smaller and this is something we have been working on and it tends to be on a project basis whether it is computer or storage or security and a lot of the data centers in the public -- in the private enterprise on prem are starting to look more and more like the public cloud.

In terms of R&D for routing, it is an area we have invested in pretty significantly, we did not just start now. We have been on it for the last couple of years and we continue to see that as an important thrust.

We continue to believe that we lead with high R&D as a percentage of revenue and that will be a metric of important investment for us. So both switching and routing are factored in that R&D and definitely we are increasing our investment in routing protocols.

But all still within that 20% to 22% of revenue that we have talked about, right.

Exactly. Within the business model we have.

Thank you.

Vijay Bhagavath, Deutsche Bank.

Thanks. Hi, Jayshree. Hi, Ita. Question and a quick follow-up. Any update on timing on customs approval for the software work arounds that you have submitted?

Would you anticipate any delays in this work around approvals? Then, Jayshree, quickly any concerns on potential shared loss to Cisco in the near-term if customers would see higher lead times for their purchase orders? Thanks.

On the customs maybe you don't want to add to that but we've always said that typical cycle for customs approval can be anywhere from two months to a year and so we don't have much else to add, we don't have an update. When we do get an update we will share that with you.

There's really nothing new. Vijay, we probably wouldn't expect to see anything new at this point.

In terms of share loss we still talk about share gain not share loss, so I hope that's our trend and we will do everything to continue to gain share.

Thank you.

Ryan Hutchinson, Guggenheim.

All right, Jayshree, I got 16 more questions on supply constraints. (Laughing) Let's see, I just wanted to step back a second here and look and think about next year, specifically Q1 given the supply constraints and the manufacturing transition.

How should we think about seasonality? Will it be down greater than Q1 of 2016? Any broad strokes just so we have the right starting point as we think about 2017 and we don't get ahead of our skis, thanks?

Yes, and that is why I think you should separate demand from our short-term shortages. You should think of Q1 as always seasonably flat to down like it has been the last few years. Even if we were to get ahead and increase our demand and fulfill it and get over all our shortages, that's not going to take care of the fact that usually six weeks out of the quarter in Q1 there is not a lot of customer interaction and engagement.

Separate those two issues. We will work on shortages but seasonality is what it is in Q1.

Something similar to what we have seen in 2016, I guess?

Yes, I think so. 2016, 2015, 2014, we have got five years to spend on this.

Finally, maybe just some quick comments on Anshul and the promotion there and what does that mean for Arista and what does it allow you to do?

It allows me to sit back and tell others what to do. (laughter) Just kidding.

First of all, I think Mark Smith and his team have done a fantastic job and this is truly a recognition of an individual. Anshul, who has teamed with Mark, teamed with product management, teamed with the engineers and personally also ran systems engineering and customer advocacy for nine years in the company and really says what he does and does what he says the Arista way. So it is recognition of Anshul.

As you know there's a lot of customer facing functions that need strategic thought. It needs depth and technology and it needs unification. I think what you are really seeing here is the acknowledgement and promotion of a fantastic individual who deserves it, earned it and is going to be very much the future of Arista.

Okay, perfect. Thank you very much. Appreciate the color.

Thanks, Ryan.

Kulbinder Garcha, Credit Suisse

Thank you. Most of my questions have been answered. I just want to clarify one thing. The mix between US and (technical difficulties) west manufacturing you are assuming all that is embedded in your gross margin guidance. Is that going to continue to change more towards the US going forward, the foreseeable into next year.

Could there be a more step downs in gross margin or is this roughly where you going to be midpoint let's say. The second question I had was with respect to the routing and he routing product. My understanding was it would be (technical difficulty) materially terms of revenue into 2017 but then Jayshree mentioned (technical difficulty) you want to get to 100 customers by Q2.

Are those two the same statements in essence? (technical difficulty) clear on that. Thanks.

Yes, to go back to gross margin, Kulbinder, I think what we've always said is that the manufacturing in the US in and of itself is not the biggest driver of gross margin, right. So we are migrating to be more heavily dependent on the US manufacturer and that was always the plan in Q4. You are seeing some impact of that in the gross margin guidance in Q4.

For it to go beyond, go below that then we would have to have a protracted period of time where we cannot import components and we start to leverage the US supply chain more and more and that's when we would see something like the 60% at the lower end of that range. I cannot tell you exactly what's going to happen here because there is obviously some unknowns.

But I think that's the framework to think about is if we become more and more US supply chain dependent then that's when we would hit the bottom end of that range. If we are manufacturing but still leveraging other components, then something similar to what you are seeing in Q4.

Thanks, Ita. And Kulbinder to answer your routing question I think the materiality of revenue will take time. It will be second half 2017 or 2018 but the acquisition of customers is a great starting point.

As we can qualify our platform to not just be the world's best spine switch but also enable routing capabilities. This will get customers very comfortable in making this shift if you will from a router versus routing. It is different.

We are doing VXLAN routing, segment routing, MPLS light without all the traditional traffic engineering, leaf spine architecture. So there's a lot of trial to think about and that's why the first metric for me is winning the customers and in their hearts and minds. Then next material revenue metric would come later.

It is also going to be challenging to measure the revenue metric because sometimes you won't know if they are using it as a switch or a routing platform or both. In many cases it maybe it may be a combination of both.

Okay, thank you.

Rod Hall, JPMorgan.

Yes, hi, guys, thanks for fitting me in. I have a couple questions actually. I wanted to go back to the HPE agreement and just talk a little bit, we understand that all the channel deals have been done there which is great news for you guys.

But how are you going to prioritize channel still there, Jayshree? Are you going to even be able to populate the channel or is there overlap and you've already got inventory out there in the channel that they can start selling. So I am just curious how that's going to work or if they just have to wait until some of these other customers get served.

Then also wanted to ask about greenfield data center builds. We understand some of those are pushing out into early next year that a lot of us had thought would complete then end of this year or at least be ramping. I was wondering, do you guys have exposure to that?

Do you see that happening or is that really not customers you are involved with. Then lastly I guess on this US manufacturing, are we at pretty much 100% impact at the end of Q4? Or can you update us on when that impact you think is maximized so that we know what to think about on gross margins, when we think those gross margins will stabilize? Thanks.

Yes, again just to take maybe the gross margin one first. It depends on how things evolve but obviously we are waiting for some customs update, et cetera as we go through this cycle. Pure manufacturing in the US like we said is not a huge drag on the gross margin.

To hit the lower end of the range that we have talked about, we would have to be in a position where we would be leveraging the US supply chain heavily, right? That would happen obviously with more time as we have to develop some of those supply chain activities.

So I think we are manufacturing and still using Asian supply chain. You are in the range that we see in Q4. As time goes on and we don't get access to Asian components, we will become more and more dependent on US components and that's when you would see the lower end of that range. (multiple speakers)

Ita, can you help us understand that. Let's say worse case scenario, you didn't get customs approval?

It varies by component, Rod. It is very hard to try to put some timing on that. I think you know what we have tried to do is at least put bookends on the range and then we will update as we go when we know more.

Okay.

Rod, to answer your two questions on HPE distribution, our agreement is really a resell agreement and any bundling with channels and partners HPE will be leading with. We will supply the networking component and they will pile on the converged components which is the compute and the storage and sometimes the one view integration with CloudVision.

We are very comfortable that they are owning the channel and the converged piece and we are supplying the building block which is networking. No issues there. It is really a resell agreement not a distribution.

Jayshree, don't you have to give them some inventory to be able to sell it or that's just not the case, you just ship as they need it?

If they do need inventory to sell it, we will but in many cases it may be a drop ship directly to customer and we verify it in that rack over there at the customer property. So it will vary.

Okay.

Can you repeat your data center greenfield question? I did not follow it.

There have been some data points through the earnings season here suggesting that there is some big greenfield builds going on as you guys know. And there have been a number of data points suggesting those are pushing even further out into the beginning of next year than people had expected for various reasons, a lot of them to do with component shortages. So just curious if you guys have seen that same kind of thing from your point of view or are these people that are not particularly customers of yours?

Well, okay.

By the way when I talk about component shortages there, I am not talking about your specific component shortages but rather industrywide shortages.

Yes. I know. I got it. To answer your question let me take it a little broadly and I think I know who the customers are you are talking about but broadly speaking when you hear a Cloud Titan talking about their massive hundreds of millions of dollars of spend, you know it includes building facilities, power, compute, virtualization, storage. The networking is a small percentage of it.

So while we are really influenced by this spend, the spend can continue with us independent of the volatility in their overall spend because they are a small number. So we are pretty comfortable that the networking spend has a long road ahead and we're feeling quite good about Q4 here based on our guidance and next year. So, no, I don't think even if data center greenfield opportunities have shifted that they are affecting us in any negative fashion at this time.

Okay. Thanks a lot, guys.

Thanks, Rod

Simon Leopold, Raymond James.

Hey, guys, this is Victor in for Simon. I wanted to ask if any customers have expressed concern I guess regarding the increased lead times and I guess more importantly, are you observing any hesitation from customers committing to purchases given the uncertainty around the outstanding litigation issues with Cisco. If not, I guess what's giving customers confidence that they will have support for their purchases over the longer term?

Victor, I will take -- the short answer is customers do express concern on our longer lead times. There's no doubt about that.

They wish they were shorter and they wish we would go back to our predictable on-time shipments. Our on-time shipments is virtually 100% and now it is much less than that.

In terms of litigation, no change. Our customers do you want to know that we stand by our workarounds and that we are legally compliant and Marc Taxay, our general counsel who shared with you many, many times as we have, we are completely committed to and are following the law. Our customers take the time to understand that and get through the [fog] of our competitors. Some asked questions and some have deeper questions and some are not worried at all and recognize this as a protection of the competitors behavior.

Great. Thanks.

Steve Milunovich, UBS.

Great, thank you very much. You had previously alluded to 100 gigabit uptake constrained by the availability of optics. Is that now resolved?

No, it is not fully resolved. We hope it will be in Q4 or Q1.

Okay. I was curious --

Sorry, Steve, just to put that in context, these 100 gigabit optic shortages are not unique to Arista. They are industrywide.

Yes, understood. Can you give us any sense of how much business you do at the Spine versus the Leaf level and if that's going to continue to shift to the Spine?

We have not been expressively specific but we have generally said that the Leaf can be -- yes, it generally can be the Leaf and the Spine are almost split 50/50. If you don't include the accessories or if you put these optics and accessories more associated with the 100 gigs with the Spine.

And that's across all your verticals or specifically in the cloud?

I gave you a general but they don't vary too much across the verticals. Probably more Spine centric than the cloud vertical.

Okay, great, thank you.

Mitch Steves, RBC Capital Markets.

Hey, guys, thanks for taking my question. I just had one clarifying one. I hate to go back to the topic of gross margin but -- so if we look at Q4 guide it looks like 61% to 64%, which makes sense because you have some more US inventory coming in. But wouldn't that be the case for Q1 as well on the following year since all the items are now being manufactured in US?

I think we had put out the range of 60% to 65% and I think everybody kind of settled in at the midpoint of that range. That's a good place to be when we are leveraging the manufacturing plant and we have got a mix of component supply chain between Asia and the US, right. And we will see -- that's how it should be for the foreseeable future.

If it is protracted and we end up becoming more dependent on the US, then I think that is when we would see kind of below that in to the 60%-ish range that we had put as the bottom metric, right. But I think in an environment where we are manufacturing in the US and we have a mixed supply chain, the Q4 guide is pretty representative of that. If we become more heavily dependent on the US over time then that's when you would see it go below that.

Got it, thank you.

Thanks, Mitch.

Simona Jankowski, Goldman Sachs.

Hi, thank you. I had a question for Ita and then one for Jayshree as well. Ita, the DSOs were quite high, so just curious why the quarter was so backend loaded and then there was also really significant increase in current deferred revenue. So just curious what was behind that as well?

Yes, so they are somewhat linked. The DSO calc reflects the fact that there was growth in deferred revenue. There was healthy growth in deferred revenue in the quarter.

The deferred revenue portion of that is based on acceptances and if we are -- you know if we show linearity that favors the backend of the quarter then that will grow and we did see some of that. So it is a combination of shift in linearity a little bit and also the fact that the deferred revenue grew and obviously that kind of corrupts the DSO calc a little bit because it is not included in the denominator.

But what drove that shift in linearity?

I think we're seeing increasing demand as we went through the quarter and we were responding to that demand and that's just how the shipments happened.

And then Jayshree any thoughts on the implications of Broadcom's acquisition of Brocade and the intended sale of the IP networking business? Then on another M&A topic we have seen some of your competitors acquire optical component businesses. So just curious if that would be of interest for you guys not just because of the shortages near-term but also just considering that optical components keep increasing as a percent of the overall system?

No, I think the Broadcom/Brocade announcement is a very interesting and intriguing one and it also shows that the industry is consolidating. It also shows that the sand market -- fiber channel market has been very sticky but not growing at all. One that really reflects more of a chipset and OEM business than a system business. So I applaud Broadcom for thinking about it strategically.

I also applaud them for not competing with their customers and realizing that the IP networking business is not there. For goal here and they are likely to spin it off. Nobody wants to compete with their customers. I look at that acquisition quite favorably.

Obviously like all M&A's execution is important. We will be looking to see how they do that. In terms of optics I could not agree with you more, Simona. I think the whole data center connect and the integration of layer one, two, three optics, particularly for 100 gig where the optics can get very expensive, very much happening.

Our point of view on this along with Andy's is we would like to see standardization of connectors and we would like to see more diversity of supply rather than shortages. We would like to see more vendors there. I'm not sure I want to lock myself in with one optics vendor, I would like to see five or 10 of them.

Thank you, Jayshree. Thanks, Simona.

Jeff Kvaal, Nomura.

Can you all hear me okay?

This time we can, Jeff. We missed you last time.

I was here. I don't know what happened. I'm sorry.

Okay. Could I broaden on that last question about Brocade? Could you tell us a little bit more about the competitive landscape. Are the Brocade products any good? If they find the right home are they going to be more of competitive threat?

We hear a lot about Juniper's new QFX10000. Are you running into that? Help us along those lines.

Jeff, the market is $6 billion or $7 billion TAM and every competitor has their strength and weakness. I think Juniper is a very good company for service provider routing. I think Brocade is a very good sand switching company.

I think Cisco is a very good enterprise company and I think Arista is the best ever cloud networking company you saw. So you share for these vendors and it reflects that and you can see here that Brocade's been around 2% to 3% in IP networking. That's not sustainable in terms of position.

I think you have to be number one or number two to be a strong leader and I think this was a good outcome for Brocade because of that.

Okay. Then my second question is 2015 was not actually that super of a year for data center CapEx. I am wondering if -- well there was a lot of digestion underway in 2015 according to Google. 2016 has been a lot better, the CapEx is up a lot. What does the magic crystal ball tell us about 2017? Should we worry about another period of digestion after a strong 2016? Thanks.

No, I think you will always see certain companies go through digestion but if I even out the highs and the lows and we see 2017 as being a good year of cloud CapEx. Some may buy less and some a buy more and a lot of that I think becomes a long-term building and capital investment less about networking.

Okay. Perfect. Thank you very much.

Tai Liani, Bank of America.

Hey, guys, this Dariush on for Tai. Thanks for squeezing me in. I want to ask about component inventory from overseas ahead of import [ban]. Now you are shifting to your year of supply chain and you are seeing longer lead times.

So my question is how long would it take to draw down virtually all of your component inventories from overseas? Do you see a scenario where component shortages in your US supply chain could impact revenues as you draw down your overseas component inventories? Just looking at differences in lead times between components and your product lead times implies that this should happen at some point.

Yes. I mean again like I said earlier we have been thinking about this problem for a long time and we've laid out plans across the different components and we know we are not going to get into those in tremendous detail here.

Okay. Do guys use the first in first out method or last in first out for (multiple speakers) --

Yes, FIFO.

A quick last question for me. What was customer count in the quarter?

Over 4,100.

Thanks, guys.

This concludes the Arista Q3 2016 earnings call. I also want to mention that we have posted a presentation which provides additional perspective on our third-quarter 2016 fiscal 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 call. You may now disconnect.