Arista Networks Inc (ANET) 2019 Q3 法說會逐字稿

Welcome to the Third Quarter 2019 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 of the Arista website following this call.

I will now turn the call over to Mr. Charles Yager, Director of Product and Investor Advocacy.

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, 2019.

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 the 2019 fiscal year, longer-term financial outlooks, industry innovation, our market opportunity, the benefits of recent acquisitions and the impact of litigations, which were subject to the risks and uncertainties that we discussed in detail on 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 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, Charles.

Thank you, everyone, for joining us this afternoon for our third quarter 2019 earnings call.

Our profitability growth combination was once again demonstrated with a non-GAAP revenue of $654.4 million with a non-GAAP earnings per share that grew to a record $2.69.

Services contributed approximately 15% of revenue.

We delivered non-GAAP gross margins of 64.4%, influenced by a solid performance from our cloud titan and enterprise verticals.

In terms of customer trends, we registered a record number of new customers in Q3 and continue to drive this new customer logo expansion at the rate of 1 to 2 per day throughout the quarter.

For calendar 2019, we do expect to have 2 customers that will be greater than 10% of our revenue, Microsoft and Facebook.

In Q3, the cloud titan vertical segment remained our largest one.

The modern enterprise segment is now consistently becoming our second largest with financials in third place, and service provider and Tier 2 specialty cloud providers coming in at fourth and fifth place.

In terms of geography in Q3, the international contribution was 19% with the Americas at 81%.

In terms of new products, we introduced important enhancements to our CloudVision platform, dubbed CloudVision 2019.

Arista's CloudVision is bringing cloud principles for network operators across places in the cloud, optics as we call it.

The largest cloud providers in the world have driven advancements in telemetry and automated network operations that improve many of the same network operations staff for the enterprise.

CloudVision up the ante to deliver these analytic and telemetric capabilities to organizations in the enterprise of many sizes.

Key highlights of CloudVision 2019 include dynamic scale, elastic agility, deep visibility and open integration where we can derive visibility metrics from SDK and S&P capable platforms, including managing third-party devices to bring multivendor capabilities across the entire enterprise.

I would like to offer some further color on Q4 2019 guidance given our significant drop.

After we experienced the pause of a specific cloud titan's orders in Q2 2019, we were expecting a recovery in second half 2019 for cloud titan spend.

In fact, Q3 2019 is a good evidence of that.

However, we were recently informed of a shift and procurement strategy with a material reduction in demand from a second cloud titan, reducing their forecast dramatically from original projections for both Q4 2019 and for calendar 2020.

Naturally, this type of volatility brings a sudden and severe impact to our Q4 guidance.

Given this tepid forecast and volatility of this cloud segment, we believe the cloud titan forecast should be modeled as flat to down in calendar 2020.

I do want to take an opportunity to reiterate that our market share for both 100-gig and overall high-performance switching remains solid and strong.

We are proud of our strength in the enterprise and financial segment with growing success in our very first quarter of shipping cognitive campus portfolio products, which is now on track for $100 million in the first full year of shipments.

With that, I'd like to turn it over to Ita for more specific financial metrics.

Thanks, Jayshree, and good afternoon.

This analysis of our Q3 results and our guidance for Q4 '19 is based on non-GAAP.

It excludes our noncash stock-based compensation impacts, certain acquisition-related charges and other nonrecurring items.

Further reconciliation of our selected GAAP to non-GAAP results is provided in our earnings release.

Total revenues in Q3 were $654.4 million, up 16% year-over-year and above the midpoint of our guidance of $647 million to $657 million.

Service revenues remained strong, representing approximately 15.2% of revenue, down from 15.6% last quarter, reflecting a typical seasonality of service renewals.

International revenues for the quarter came in at $122.1 million or 19% of total revenue, down from 27% in the prior period.

This volatility and geographical mix is largely driven by a shift towards U.S. deployments in our cloud titan business.

Overall, gross margin in Q3 was 64.4%, above the midpoint of our guidance of 63% to 65% and down slightly from 64.7% last quarter.

This reflected a healthy cloud titan contribution combined with good performance from our enterprise and financial verticals.

Operating expenses for the quarter were $163 million or 24.9% of revenue, up slightly from last quarter at $158.7 million.

R&D spending came in at $105.3 million or 16.1% of revenue, up from $101.7 million last quarter.

This reflected head count growth and slightly higher levels of product NRE and prototype spending in the period.

Sales and marketing expense was $46.8 million or 7.1% of revenue, up from last quarter with increased head count somewhat offset by reductions in other sales costs.

Our G&A costs were consistent with last quarter at approximately $11 million or 1.7% of revenue.

Our operating income for the quarter was $258.2 million or 39.4% of revenue.

Other income and expense for the quarter was a favorable $14.9 million, and our effective tax rate was approximately 20.5%.

This resulted in net income for the quarter of $217.1 million or 33.2% of revenue.

Our diluted share number for the quarter was 80.75 million shares, resulting in a diluted earnings per share number for the quarter of $2.69, up 27.5% from the prior year.

Now turning to the balance sheet.

Cash, cash equivalents and investments ended the quarter to approximately $2.4 billion.

We repurchased $115 million of our common stock during the quarter at a weighted average price of $224 per share.

As a reminder, our Board of Directors has authorized a 3-year $1 billion stock repurchase program commencing in Q2 '19.

This program allows us to repurchase shares of our common stock opportunistically and will be funded with operating cash flows.

We generated $269 million of cash from operations in the third quarter, reflecting strong net income performance and a decrease in working capital requirements for approximately $25 million.

DSOs came in at 63 days, up from 51 days in Q2, reflecting the timing of billings in the period.

Inventory turns were 3.1x, up from 2.4 last quarter.

Inventory decreased to $239.8 million in the quarter, down from $314.2 million in the prior period.

Our total deferred revenue balance was $529 million, up from $502.2 million in Q2.

As a reminder, our deferred revenue balance is now almost exclusively services related with any significant product deferred revenue amounts having been recognized on the income statement in the first half of the year.

Accounts payable days were 31 days, down from 37 days in Q2, reflecting the timing of inventory receipts and payments.

Capital expenditures for the quarter were $4.7 million.

Now turning to our outlook for the fourth quarter and beyond.

We continue to experience significant volatility of demand from our cloud business.

We saw a strong recovery from the customer who had paused activity in the second quarter, only to be surprised by a dramatic reduction in forecast for Q4 and 2020 from another key titan.

All indications or these actions do not represent a loss of positioning our share for Arista at these customers, but will likely affect -- will likely result in demand from this part of the business being flat to down on a year-over-year basis for the remainder of 2019 and into 2020.

While we're not at this point in a position to provide overall guidance for 2020, we did want to make of the following points.

Firstly, a recap on deferred revenue and its impact on 2019 results.

As outlined on prior calls, we recognized $80 million and $38 million of non-Microsoft product deferred revenue in Q1 and Q2 '19, respectively.

These amounts represent product sales shipped and billed in the prior year for which revenue was deferred pending customer acceptance of legal redesigns and features.

While not impacting our 2020 cash metrics, this does set up some tough comps for year-over-year revenue growth, particularly in the first quarter of 2020.

At this point, we believe these trends combined with typical Q1 seasonality, and the recent updates to cloud forecast described above may result in revenues for the first quarter of 2020 that are approximately 5% below Q4 '19 levels.

On a gross margin front, we would reiterate our overall gross margin outlook of 63% to 65% with customer mix being the key driver.

We'll continue to manage investments in the business carefully with targeted growth in sales and R&D head count, balancing the need to expand our market coverage with prudent financial management.

Finally, you should expect to see us continue to execute against the stock repurchase mandate in an opportunistic manner.

With all of this as a backdrop, our guidance for the fourth quarter is based on non-GAAP results and excludes any noncash stock-based compensation impacts and other nonrecurring items is as follows: revenues of approximately $540 million to $560 million, gross margin of approximately 63% to 65%, operating margin of approximately 36%.

Our effective tax rate is expected to be approximately 20.5% with diluted shares of approximately 80.3 million.

I will now turn the call back to Charles.

Charles?

Thank you, Ita.

Now I'm going to move to the Q&A portion of the Arista earnings call.

(Operator Instructions)

(Operator Instructions) Your first question comes from the line of Simon Leopold with Raymond James.

Appreciate the added disclosures and details you've given us on this call, so thanks for that.

I wanted to maybe get a better understanding of the 2020 commentary, given that at least looking at CapEx as an indicator or revenue for business lines like Azure and AWS seem to be encouraging suggesting 2020 could be a better year in terms of the CapEx forecast going back up double digits for the web scale guys.

Just wondering how you think we should square your more cautious tone on the cloud relative to looks like better capital spending trends and healthy revenue trends from the WebTitans?

Thank you, Simon.

Well, as I was trying to explain, our Q4 forecast is actually quite consistent with many of the cloud CapEx reported in recent calls, which is overall flat to down.

There's a lot of volatility going on

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going down, but the overall trend for Q4 is down, and we're projecting that same flat to down trend for CapEx next year for the overall cloud titan spend.

Now one of the things that, as you know, you may have remembered this, we were not tracking from a networking point of view in prior years with cloud CapEx nearly as know as well.

So there's not a one-to-one correlation.

And in some cases, what we're seeing in the cloud CapEx is the redistribution to infrastructure not to networking.

So if you look at the 2 reasons why we believe it will slowdown also in 2020, it's because many of the cloud titan customers are extending their use of server assets and delaying the network purchase longer and buying other infrastructure or investing in other aspects.

And the second is the 400-gig adoption.

We have predicted initially that deployments could start as early as second half this year.

We are shipping 400-gig products for initial trials this year, but the initial deployments have shifted by more than a year to second half 2020, and we think mainstream production will be 2021.

So the change in customers extending their investments and the deployment of 400 gig is causing us to be more muted about 2020.

Your next question comes from Tim Long with Barclays.

If I could just follow-up on the cloud titans again.

Maybe just a 2-parter.

Number one, could you talk a little bit about the customer that had the recent sudden change, and it seems it has a long tail to it as well?

Any visibility into why they're doing it as their business is changing?

Or is it just, as you said, just the spending is changing?

And secondly, do you think this is a trend that highlights more even more than flat to down risks for some of the other large customers?

Okay.

So specific to the cloud titan whose forecast reduced dramatically, I think there are 2 main reasons.

And I'm going to ask Anshul, our cloud expert and COO to elaborate.

First is they are managing the CapEx for networking and modulating the inventory and shifting to more of a just-in-time type forecast.

So typically, they gave us 2-quarter visibilities, sometimes even 3 and 4, and now they're moving much more to a real-time forecast at quarterly intervals.

And the second is this particular cloud titan is extending that services by more than a year.

And once the sub assets get extended, that is significantly delaying the network spend, too.

Anshul, do you want to add to that?

Jayshree was absolutely right.

The server request delay is a specific decision for this one cloud titan.

They didn't see enough ROI in doing the refresh just right now, they might wait a generation and hence, the impact we are seeing as well because they want to upgrade the network if they're not updating in October.

And so to answer your -- the other part of your question, Tim, on other cloud titans, some will be stronger, some will be flat, some will be weaker.

But as we average all of that, we see flat to down.

Your next question comes from Ittai Kidron with Oppenheimer.

I guess I want to follow up then on your recent explanation here, Jayshree.

The -- I mean the CapEx moving to just-in-time, that shouldn't affect your business.

You might not have visibility, but that still remains business needs to come as long as you keep building.

I guess moving to the server refresh cycle, is that where the bulk of your business with that cloud titan was and just kind of refresh upgrade of existing platform as there was no new builds with this customer?

Bulk of it was -- there's always multiple levels of connectivity.

Bulk of it is obviously the first layer, you got to build servers for us to put a network.

The second layer is usually regional spine and data center

(technical difficulty)

Okay.

Ladies and gentlemen, please standby, we are currently experiencing technical difficulties.

The conference will resume momentarily.

Thank you for your patience.

The next question, please?

Is that good?

Did you hear the answer, lttai?

Yes.

If you could repeat it.

I think everybody got disconnected in the mill.

I hope it wasn't something I said.

No.

But now I have to remember your question to repeat the answer.

The question is -- again, reiterating the question regarding the nature of your business with them, is it just tied to a server refreshes there, no new build -- no greenfield build with them?

Yes.

No, and the answer is, clearly, don't starts with -- if you don't have servers and storage, we can't connect with the network.

So the nature of our use cases starts with server spend correlates to network spend which, in turn, creates layers of additional signs, which can be the aggregation or the regional signs as well.

But that is the symptom and the cause of more networking spend.

Now that doesn't mean they don't spend on new data centers, I think the CapEx of many of the cloud titans, including the one we're discussing, reflects that they will spend in a healthy fashion on the infrastructure for new data centers.

But to correlate that back to networking will take time because, first, they have to buy the new servers and then they have to buy the network, which could go well into late 2020 our 2021 most likely.

Very good.

Maybe as a follow-up, Microsoft just won the JEDI contract.

What does that mean to you?

How do you look at that?

And what it could do for your business?

Well, we're very pleased with that.

And as you can imagine, Anshul and her team worked very hard on several certifications and partnerships with our cloud titan vendors.

Having said that, the first thing that happens with these large contracts is they get contested.

And so while the award may be given, we think it will time for us to see the material benefit.

It may take 6 to 12 months.

Your next question comes from Samik Chatterjee with JPMorgan.

Just moving beyond your commentary about the volatility in spending from the cloud titans.

I just wanted to ask about the Tier 2 cloud providers.

It sounds like you have more visibility or more stability in terms of what you're seeing in terms of spending patterns from them.

Is that kind of fair?

Or what you -- if you can kind of elaborate on what you're seeing on that side.

And does this kind of drive you to focus more on that segment going forward?

Yes.

Samik, thank you.

While majority of our guidance was due to the specific cloud titan, you might have noticed in my commentary that both the service providers and the specialty Tier 2 cloud providers came in at fourth and fifth place.

I think this is the first time the specialty Tier 2 cloud providers have been dead last.

And in my view, the segment is weak and the results have been mixed.

I think the new Tier 2 company -- specialty cloud companies that started growing very well for us in 2017 and '18 are now having to review their investments and decide from a matter of economics, which ones make more, do they rely on their own cloud or go to the public cloud titan.

And some of the Tier 2 companies are finding it difficult to compete, some are continuing with the strategy.

So it is a mixed bag for us.

And especially in Q4, we don't expect much success from this category.

Your next question comes from Alex Henderson with Needham & Company.

I was hoping you could spend a little bit of time relative to this cloud issue.

To what extent you're confident that there is no competitive encouraging here that's causing it and that, in fact, you have sustained share at that customer?

How can we judge that?

How do you get your arms around clarity around that point?

Alex, that's a very good question.

From our perspective, the competitive dynamics have not changed in the cloud or in general.

We always have aggressive competition, and we will continue to see aggression there.

But what gives us confidence, the cloud titans are delaying their spend or distributing their CapEx differently, is, as you know, we always pride ourselves in a close partnership and relationship with cloud titans.

And generally, especially in the case of Facebook and Microsoft, they have been not only a vendor-customer relationship, but really a core development that requires the kind of partnership, which is engineering to engineering.

It's not just business.

So when you look at that, there's no evidence that competitively all white box-wise, there's been any change.

There's been a process change.

There's better inventory management.

There's better procurement, optimization, et cetera.

And you can always expect these cloud customers of ours who want to be multisourced, but it isn't any different than we've seen in the past in behavior, in relationship, in our innovation.

We have 10 400-gig products, and a lot of them are in trials.

So the relationship and the technology partnership couldn't be better.

Anshul, do you want to add to that?

Sure.

Thanks, Jayshree.

Alex, we work very closely with these customers to a point where we are working on the 2021 road map along with these customers right now, and are quite well aware of the changes they're making to the architecture as well and have very direct feedback from customers as well that there is no (inaudible) that's displeasing us.

It's simply the demand has gone down, and we are very confident of our shares when that demand comes back as well since we collaborate with these customers.

So we're not worried about it, and the customers are pretty -- being pretty direct as well.

This is not our share going to someone else, their demand reduced.

Your next question comes from James Faucette with Morgan Stanley.

Adding my follow-ups to the other questions that have already been asked.

On this change in architecture and strategy and what they're doing with their servers, is this related to how they're implementing servers and networking obviously by extension so that we're looking at a permanent lengthening of replacement cycles?

Or is this somehow just related to the current cycle?

I guess I'm trying to get a sense for what the -- even as the customers come back, what the opportunity is and how we should think about the frequency that they'll need to come back and add additional capacity or upgrade networking equipment, et cetera?

Yes.

No, good question, James.

You may know that several cycles tend to go in 18 months to 3 years, and generally they get upgraded in that type of time frame.

In this particular case, because of the server vendor and architecture, the server vendor, there's no change in server architecture, I have to emphasize that.

They are choosing to delay their server -- new server deployment by at least a year.

So it's no more, no less.

No change in architecture, but really a delay of server spend, which is causing a delay in network spend.

Great.

And then that has some short-term impact on from the IO needs from the servers.

If there's no new server, they may not need as much new IO that we're planning on.

But in the long run, these things do balance out just the near-term adjustment of 1-year type of cycle until they do start their refresh.

Your next question comes from Aaron Rakers with Wells Fargo.

Maybe I'll shift gears a little bit.

As you think about the model and the growth rates that you've outlined looking into next year, I'm just kind of curious, do you take a more active stance in kind of protecting the margin profile of the company?

And how do I think about just the investments that the company has previously kind of alluded to that would be required to really position yourself for a campus ramp as we move into next year?

And just any kind of commentary on how you've seen campus thus far?

Yes.

I mean I think I'll take the model question and, Ita, if you can take the campus question.

I think as we think about the business as we go forward, I mean I think we believe we can operate healthily in the plus or minus 35% operating margin model that we've talked about for some time as we talked about as part of the long-term model.

We're guiding 36% for Q4 even with the kind of reductions in revenue, right?

So we do have some flexibility there, but I think you have to probably expect that you won't see the 39% and 40% type operating margin numbers that we've been putting up more recently.

So we will continue to make investments, they'll be targeted.

We'll continue to -- you'll see us continue to invest in the sales and marketing side because we believe that's important as we go forward, and some head count, et cetera, and some R&D as well.

But we think we can still do it within that envelope.

Yes.

And regarding -- Aaron, regarding campus, as I said in my opening remarks, we are marching well to the $100 million in shipment for the first full quarter.

Q3 was our first quarter.

What surprised me pleasantly on our campus acceptance is half our customers were existing, but half were new.

If you were to ask me to forecast that, I wouldn't have betted that.

I would have thought 80% would be existing.

So we're really getting a lot of interest in our campus.

In fact, I would say one of the strong reasons our enterprise segment is #2 is not only because of the data center, but small numbers on the campus in Q3, but I believe the 2 will influence each other, that we will become more relevant in the enterprise because of both campus and enterprise and the architectural shift that we can guide to public workloads versus private.

I think -- when I look at why, we're very differentiated.

The word cognitive to us is really architectural both on our Wi-Fi and PoE switches and display with CloudVision.

So customers are really appreciating our differentiation on flow analysis, on security, on bringing an integrated cognitive secure software-driven integration together, much like we did with the data center.

So we like our early progress and execution there.

Your next question comes from Alex Kurtz with KeyBanc Capital Markets.

I'm more of clarifications than a question.

I just want to make sure we all understand that the account that's driving this downside here is not your historically largest customer.

And then the second part of that is, given the disruption that you saw from Microsoft earlier in the year, I guess what's the context of their spend level as they go into Q4 and into the 2020?

So just to clarify, Alex, it's the second cloud titan.

It's not the one we mentioned the last time that had a Q2 2019 call.

And specific to Microsoft, as we are projecting, we expect -- we fully expect them to be a north of 10% customer concentration for 2019, and we expect to have a second new cloud titan customer, which will be Facebook.

And just into 2020 around Microsoft, just given the disruption we saw this year, Jayshree, how do you -- any early read on kind of returning to a more normalized spend in 2020 with them?

Anshul, do you want to say a few words.

Sure.

Alex, so far, we don't have a long-term guidance for Microsoft, but there is no -- nothing different than they are on a usual spend patterns as we have not given any other methods.

No blip, no pause.

That's correct.

Not yet.

Your next question comes from Tejas Venkatesh with UBS.

As you reflect on the fundamental technology drivers of bandwidth growth in the cloud that contributed to very strong growth over the years, has anything fundamentally changed?

I asked because, this year, we have had sort of 2 different cloud vendors have some sort of hiccup.

One was probably a public cloud vendor, the other content cloud vendor.

So completely different drivers, and yet you're seeing a pause.

So is there any sort of technology fundamental change?

Tejas, I don't see any fundamental change.

I think our strategy in TAM is valid.

I think their strategy that they want to invest has been very strong the last 4, 5 years.

Perhaps the only change I would allude to is they're adding more process, more optimization, more care and feed into their forecasting, more discipline, more hygiene, but I don't see any other change.

I think they continue to invest for scale.

And as you know, they're all doing very well, but that doesn't mean they will spend equally well.

Anshul?

This is -- the pause that we mentioned in Q2 was really tied to some internal financial planning for the customer and inventory planning.

It's about nothing to do with the architecture of the brand within front.

And the second instance you're seeing right now, the other cloud titan there somewhat refresh.

But when you model this out long term, there is no change in their growth expectations of traffic and networking needs both from a bandwidth standpoint as well as backbone and traffic during this.

And with video storage and now AI workload is growing, there is evidently more and more need for networking.

So we're not seeing that trend change, but obviously we have to wait for the customer to come back and do the -- start the refresh.

And as a quick follow-up, any change in enterprise spending?

I realized your share of that market is lower, but are you seeing any deal elongation and so forth at all?

Too early.

As we say, we are not bellwether on enterprise.

So I think we know -- we understand the cloud much better because we are a new entrant and we have new products, so we're probably not the best indicator of change.

Your next question comes from Jim Suva with Citi.

I just have one question.

The change in the procurement strategy of this cloud titan, why won't it spread to both other cloud titan and maybe even the second tier cloud titan?

Is there a risk of that?

Or any visibility of why this challenge won't spread?

Thank you, Jim.

I'll comment and I'll have Anshul elaborate.

I think the short answer is, no, we don't see a lot of risks of that because, anyway, our visibility was 2 quarters.

With this particular titan, they have optimized it to one quarter.

So if we're always relying on 1- and 2-year forecast, that would be a bigger dramatic change to our belief system and how we plan with them.

But since it's always been 1 or 2 quarters and a further refinement on this particular cloud titan customer to 1 quarter only, we don't see a big change or a big shift.

Right.

And then this is their own internal process and planning on how they plan networking purchases with respect to data center facilities going live.

And they are optimizing their processes and their org and fixing issues they might have in the past.

This does not apply to any of our other cloud titans.

So very specific to organization issues in the company, not in industry trend or technology trend.

Your next question comes from Rod Hall with Goldman Sachs.

I wanted to just check what you're thinking on growth in 2020?

I'm just playing around where the verticals here and thinking about what maybe you're implying with this.

So I wonder if maybe you could put us in some sort of a ballpark for overall revenue growth and then talk to us about why you the down 8 or so that you're implying in the guidance doesn't kind of materialize through the -- a better part of next year, so you end up with even lower revenue growth or maybe that's what you're already thinking.

So that's one thing, if you could just put us in some kind of a revenue growth ballpark for next year?

And then the other thing I wanted to ask is enterprise spending is clearly very weak and a lot of the rest of this growth depends on enterprise.

And so I wonder if you could just update us on what you're seeing there?

How much risk you think there is to our enterprise numbers as we look into 2020 or at least the early part of it with the slowdown that we're absorbing.

Yes.

Rod, I'll take the first part of that and then maybe hand out to Jayshree on the last part.

I mean I think from a model perspective, we're not yet trying to call 2020 growth rate for the overall business.

I think we've tried to put some points out there and make sure everybody is aligned on some of the impacts from deferred, et cetera.

But I think as we entered the year, we will have a tough comp for the first quarter, particularly in the second quarter as well to some extent because of the deferred.

We talked about the cloud vertical being flat to down.

What we've seen pretty consistently is that the enterprise part of business, the financial verticals have been growing well, and they've been offsetting that, although not entirely, right?

And we hope that, that will continue -- that we continue to see that.

So that's kind of an offset to -- so the other part of business, which is really in the cloud and service provider piece, which has been muted as we gone through this year.

And in Q1, I think we pretty much guided the Q1 number only because we want to make sure we've reflected the deferred correctly and that we reflect the seasonality of Q1 correctly in your model.

Okay.

And then enterprise, if you want to tell us...

Yes.

On enterprise, I do believe, from a demand and TAM perspective, we have a lot of opportunities for execution.

And we could do very well both in enterprise and financials.

If we get affected by macro situations, that affects everyone not just us.

So we would be influenced by that.

But barring any macro situation, we feel very good about our execution to date and going into 2020, and that will hopefully offset some of the flatness in the cloud.

Just coming back on the numbers, I mean -- just to see whether...

(inaudible)

Go ahead, Rod.

Okay.

Well, I was just going to say, I mean it looks to me like it could easily be mid-single-digits growth next year.

And I don't know if that's a crazy number from your point of view or is that a plausible scenario.

I don't think it's a crazy number.

We'd have to grow enterprise into significant double-digits.

I think at this point, we're not feeling strongly optimistic about the mid-teens growth that we projected at the Analyst Day because of how poorly cloud is doing, right?

Everything else is -- and the enterprise and financials is doing well, but how about you give us -- looking into Q4, Q1 and then we'll come back to you.

We don't know.

Your next question comes from Amit Daryanani with Evercore.

I guess a question of clarification.

Just to ensure the entire $130 million revenue mix versus the Street at least.

Was that all attributed to this cloud titan customer shifting patterns?

Or was it something else?

That's one part.

And then secondly, maybe we just touch on what do you see on the enterprise side?

And do you think Mojo could be a meaningful driver for revenue growth as you get into calendar '20?

Yes.

So to quickly answer your question, Amit, the specific titan was absolutely the largest part of the gap, the -- in guidance, but there were declines.

As you know, we've had a deteriorating declining performance and service provider and new to the mix was a deteriorating and declining performance in Tier 2 specialty cloud, too.

So it was a combination of all 3, but majority being one specific cloud titan.

Now specific to Mojo, Mojo is very much factored into our campus numbers, and we think the whole wired, wireless cognitive edge is really getting ignited with the merger product.

We have completed our integration of CloudVision and Wi-Fi.

Our distributed load managed Moju is better than any -- many of the standard controller offerings and legacy offerings in the marketplace.

So we believe our campus is doing well, and a good contribution from that is Mojo.

Your next question comes from Brian Yun with Deutsche Bank.

Can you talk about what's changed on the 400-gig side?

It sounds like you anticipated deployments for 400-gig have been pushed out 1 year from your initial estimates.

So kind of interested to get your view on what you think is causing those delay deployments.

Well, I think when we first begin our 400-gig foray, you may have remembered Andy Bechtolsheim spoke about it, we were always concerned not whether that we would have products and differentiated ones, which we do, we're shipping 10 types of products now, but whether the optics was ready and the ecosystem was ready.

So we thought the ecosystem will be ready by now and the optics has pretty moved a year.

Correct me if I'm wrong, Anshul.

So by virtue, you can have 400-gig products and anything more than trials, if you don't have good optics to connect to it.

So by virtue of the 400-gig optics moving out, we believe most of the initial deployments will move from second half this year, which is what we thought before the second half 2020, which means production installation.

Production installation is when you go from thousands of ports to a million ports will really be 2021.

So -- but I want to be clear that we are shipping 400-gig products.

We're very proud of them.

And as always, we're ahead of the industry.

Your next question comes from Paul Silverstein with Cowen and Company.

Jayshree, I hate to be the umpteenth person to ask you about cloud, but I will be.

Two related questions, if I might.

One, I just want to make sure if I heard you correctly first before the question, which is you said 2 10% cloud titan customers, Microsoft and Facebook, for 2019.

Was that the same in terms of the time period?

Yes, that's right.

Okay.

And you also said that the particular cloud titan in question is the problem shifted to 1 quarter from the 2-quarter forecast, correct?

Well, we forecast the -- we're anywhere from 2 to 4 quarters and is now shifted specifically to 1 quarter.

All right.

Here are the 2 questions.

One, with respect to the softness in 2020, putting aside for 4Q '19.

With respect to 2020, you made the point previously that with Microsoft when you had that -- when they went cold turkey previously, you said the real question is in them coming back, but to what degree?

So when you talk about the softness, a significant decline in 2020, I presume they've given you that insight, notwithstanding a shift to 1 quarter of forecast away from the previous 2- to 4-quarter forecast.

It sounds like they've given you visibility into next year.

How much softness are you talking about or you're expecting at this point?

The other related question is somewhat different, but...

If you're going to allow me to answer that, Paul, then we can get to the other questions.

This particular cloud titan has not only given us a dramatic reduction for Q4 2019, but has given us a dramatic reduction for much of 2020.

So unlike the other cloud titans, there is a pause and they come back and it's more consistent, we fully expect this particular cloud titan to reduce next year significantly.

Okay.

All right.

And then on the broader question, 400-gig, correct me if I'm wrong, but I think you made this point publicly in the past that with respect to your business, it's selling intra-data center switches for Leaf & Spine and Top of Rack, there is a 12.8 terabit upgrade cycle driven by new Broadcom silicon, Tomahawk, and Trident as well as Innovium equivalent.

In that -- if 400-gig optics aren't ready, the various cloud titans will buy before higher capacity switches that you and Cisco and Juniper introducing, and they'll just deploy them in high-density 100-gig configurations until the 400-gig is ready and/or is at the right price points.

That sounds like -- it sounds like you've changed thinking on that?

No.

There's no change in the thinking that Jericho and Tomahawk, Trident will be used with higher capacity in 100-gig configuration.

So we'll continue to see incremental deployments of that.

No change there.

But there won't be a wholesale change from 100-gig to 400-gig in the spine until 2021.

Well, Jayshree, I can't ask you...

[On the day it] will be arriving though.

We can't ask you to speak for your customers, that will be unfair.

But doesn't that -- does that imply that there's been -- maybe this is stating the obvious, but doesn't that imply that there's been a change in demand on the part of cloud titans in general to the extent that if the demand were there -- again, instead of deploying 400-gig, they would just deploy a lot more 100-gig.

And the impact to you as a switch vendor, it would be relatively nominal.

We won't see it -- you won't see it, we won't see it.

But it clearly appears that there is a general softness in demand.

Paul, to your overall theme, we do very well and have a good products that are 12.8 terabit, 128- by 100-gig switches.

That point is well covered, and customers do buy that as necessary for the architecture.

The dramatic change for one of the cloud titans is really coming from them delaying the server refresh with delays on network change that they otherwise would have done, which we have added more capacity.

So it gets delayed until they start that refresh because these architectures go hand-in-hand.

You don't touch the network and the servers independently, it goes together in our customer and the market whole architecture.

On the 400-gig side, the industry delays are in general because we haven't seen the entire ecosystem.

And many of these optics companies forgot about backlog compatibly, we're still in work with the cloud companies because 400 has to work with 2 by 100 on the other side and so on.

Otherwise, you can't upgrade a large network.

And everyone's going through those motions to get the entire ecosystem ready, which will take at least a year before it starts getting the side of production.

Your next question comes from Jeff Kvaal with Nomura Instinet.

I guess I clearly understand the downtick in cloud spending over the course of the next few quarters, and I guess no we want to start thinking about what your comments mean about where we might come through the other side of that.

It sounded as though 12 -- or 18 to 24 months after a server refresh, is it over as the difficult time frame?

If you push it out 6 months for whatever reason that would strike me as being maybe in the fourth quarter of 2020, but more likely 2021, is -- does that math kind of work out?

Yes.

Jeff, I think the reason we are saying that cloud titan forecast to be flat to down in 2020 is because any projections of optimism and growth is the earliest possible is Q4 2020.

We really think the impact of 2021 to get beyond the flat to down forecast.

And you're right, a server cycle that's delayed by a year, I mean it's a year from now, which means any impact to IO is a year from now.

Any kind of production deployment is over a year from now.

So I think 12 months is a good rule of thumb as a minimum.

Your next question comes from Sami Badri with Crédit Suisse.

I'm just trying to square away some of the commentary here and to give you some context before my next question.

Is that -- some of the third-party multitenant colocation providers have reported some of their strongest backlog orders all for data center capacity commencing in Europe in 2020.

Now the fair majority of those big bookings are actually being driven by cloud titans.

So as these cloud titans expand internationally, is there a difference in topology architecture that is taking place because of the way they're building or the way they're connecting?

That means that possibly alternative vendors would be more favorable?

Or is this just a completely different -- are we looking at something that is completely uniquely different where we've seen before?

Sami, typically, the cloud titans deploy us globally.

As you know, we have a lot of international data centers that they have built with us.

And as they expand to additional data centers, the only difference is not architecture, but size of the data center.

So depending on whether they're going into highly populated densities or smaller, they don't -- they will risk and repeat the same architecture, but the scale and size may vary, which means they really, really wanted to be one uniform architecture ideally with 1 consistent software and 1 vendor.

So it is very rare to see that they would repeat it with a different vendor.

So I don't see any uniqueness in the international data center except that sites.

Next questions, please.

And then just -- sorry, one follow-up on the...

Could we go to the next -- sorry, Sami, we're running out of time here.

Could we go to the next question, please?

Your next question comes from Erik Suppiger with JMP Securities.

I just want to understand if this issue with the titans is beyond this one customer as you get into 2020 because it looks like you are reducing the outlook for Q4 by, call it, 20-ish percent of revenue, and I'm not sure if we should carry that through.

And it seems like one customer, who presumably is not 10%, why would we be cutting it that much?

So is this more endemic across the broader titan universe?

Or how should we be thinking about this?

I think what we're saying is our numbers are very large with the cloud titans, and we will do very well with some -- the smaller ones and maybe flattish to down with the larger ones depending upon the spend.

And when you cumulatively add all of this, it's going to be flat to down in revenue.

I don't think it means -- it's not a trend for overall the next 3 to 5 years, it's a projection of what specifically will happen in 2020, especially because they're going to milk their servers, leverage their existing infrastructure, keep adding 100-gig to that, not quite new to 400-gig.

We see 2020 as a transition year with our cloud titans in terms of high performance as well.

So I wouldn't read anything more to the forecast except for 2020.

Those things could pick up later on.

Your next question comes from Tal Liani with Bank of America Merrill Lynch.

So I want to understand just one thing, most of the questions were asked.

I want to understand, if you look at 2020 and you remove this one customer because next quarter you're going to have a down year -- revenue down year-over-year, and I think you said also 2020.

So now I'm trying to understand if I remove this one customer that was really bad this quarter and provided this $120 million, $130 million shortfall, then what's the underlying growth of everything else?

Is 2020 the story of one bad customer who is kind of rethinking strategy?

Or is 2020 going to be down even if you remove that particular customer?

Well, loaded question.

I think the way to think of this is we have 3 types of cloud titan, some large ones that have remained flat, some that will go down and some that will go up.

And the aggregate of that is flat to down.

Anshul, do you want to add to that?

Or did I get that right?

No, that's right.

And then...

I understand, but that's a very general answer.

I mean at the end of the day, there is one big customer who is down $120 million of $670 million.

That's a giant number.

So we have to remove that to understand what's happening with the rest of it.

So when you do the math, is the rest of it still up or it's still going to be down?

First of all, remember, the rest of it, we don't have hundreds of customers here.

We have a handful.

So the cloud....

But there's still $550 million.

Right.

The per quarter, It's still $550 million.

I mean it's still meaningful, very meaningful.

Well, I think we have to step back a little bit, it's not like we have perfect visibility of what we think is going to happen in 2020 yet, right?

I think what we're saying is, look, we have this issue with this particular customer, which is a large customer and has some significant impact.

We have the rest of cloud, which have been unpredictable this year.

That's the reality of life.

We'll see how it plays out next year, but for sure we're not as aggressively forecasting that right now, right?

We have service provider, which hasn't been performing well.

And we just saw the specialty cloud vertical kind of goes to the bottom of the list, right?

Offsetting that has been some good traction in enterprise and financials, and we saw them grow well in Q3, right?

But it's not enough to offset completely, which is why we say the flat to down is significant for the rest of the business.

Your next question comes from George Notter with Jefferies.

I know that you guys are making quite a bit of progress on the routing side.

I know there were a number of larger cloud provider customers that were looking at your routing products.

Is that an opportunity for you to offset some of the softness you're seeing in the cloud side as incremental success with routing?

And any insights there would be great.

And one other clarification, if you could just repeat the deferred revenue metrics that you referenced earlier that would be helpful.

George, you are very right.

We are doing -- we -- our strongest use cases for routing are with the cloud providers.

So despite all the servers, et cetera, these tend to be obviously stronger in value and fewer in number, but we're doing very well with virtually all the cloud providers, cloud titans on routing.

And we're doing very well in general in routing, it's improving for us on our landscape with Tier 2 cloud providers as well in the routing use case specifically.

So we do look at that as an opportunity for next year as well.

And then just on the deferred, George, kind of a continuation from what we saw in the first half of '19, right?

We have recognized $80 million of products deferred in Q1, $30 million of products deferred in Q2.

That had basically been shipped and billed in the prior period.

So from a revenue perspective, [then I would expect a softness in comp] coming into Q1.

From a cash perspective, that's -- it's different obviously because the deferred revenue didn't contribute cash for this year.

But from a revenue perspective, it's obviously -- gives you a higher mark.

Your next question comes from Hendi Susanto with Gabelli.

I would like to understand more about the cloud titans phenomenon of delaying this -- the use of its server assets.

Is there a risk that other customers whether a cloud titan or not may behave similarly?

Perhaps you can share some technical insights when a large customer can extend the use of server assets and when it cannot?

Hendi, this is -- all of the cloud titan customers have their own architecture and the choice of mix and the 25-gig, 50-gig architecture choices they have made.

And if you look at the industry, the cloud is actually not aligned to the exact same server CPU upgrade cycle.

They are offset from each other in a tick-tock manner aligned with the tick-tock updates from the industry as well.

This particular decision does seem specific to only one titan to us.

We have not heard this from anyone else, and the others keep on adding capacity as they need to.

But there's one customer for them because there wasn't enough ROI, so they decided to delay their upgrade.

So I just read it the way we have got it from our customers, and I would not add anything else to that.

Your next question comes from John Marchetti with Stifel.

I just wanted to go back to a comment and make sure that I heard you right, Jayshree.

When you were talking about the overall outlook for '20 ex the cloud business, if I go back to that Analyst Day presentation and how you guys talked about sort of cloud, adding a few points of growth to take you up into that sort of upper teens range.

If we strip that out altogether for next year or even assume, it's down a little bit.

Do we still consider the rest of the business ex that cloud still being in that sort of low double-digit to mid-teens?

I just want to make sure I heard -- the way that you answered Rod's question.

Right.

No, good question, John.

I think just going back to that Analyst Day, what Ita said or Arista said more specifically, was if the cloud did really well, we'd be in the high teens.

If the cloud did average, we'd be in the mid-teens.

The current projections we're giving to you on the cloud are below that average that we thought was the norm.

So with the new norm being flat to down, mid-teens is off the table right now for 2020.

Ita, you want to add to that?

No, I did that's right.

We hadn't contemplated a world at that point where cloud will be flat to down, right?

We were just -- that wasn't something that we were contemplating.

I mean we're kind of thinking between slowish growth and faster growth, right?

I don't think anybody that stayed would have thought that we'll be in a world where we see that part of the business actually be down or flat to declining.

Your last question comes from Andrew Vadheim with Wolfe Research.

Recognizing revenue pressures in 4Q in 2020, silver lining potentially could be through growth and other segments, just maybe campus starts to ramp over the medium term, enterprise shows strength and maybe service provider recovers.

And you would eventually start to have more of a structural business pivot to higher overall gross margin.

Is that something that you perhaps just go ahead and embrace with more immediacy and invest faster and even more heavily in noncloud, maybe the expense of cloud than you previously would have anticipated?

You're right to point out that our business hasn't fundamentally changed.

Our fundamentals are great, our gross margins are 63% to 65%.

Our TAM is valid.

We could grow in other places, but I don't think we would want to forecast below -- beyond the 63% to 65%, because I think we're in the band because -- if our cloud goes down, we should be on the higher end of the band.

If our cloud goes up, we'll be at the lower end of the band.

We don't see the band itself going up more.

That being said, we're absolutely committed to R&D.

We're absolutely committed to targeted hiring and investing.

We think we can do that like Ita said with a 35-ish percent operating margin.

And so no change in strategy in continuing to invest in R&D and sales and marketing as well as M&A where it make sense to grow our other businesses and segments.

This concludes the Arista Q3 2019 earnings call.

Please note that we have posted a presentation, which provides additional information on our fiscal results that you can access on the Investors section of our website.

Thank you for joining.

Ladies and gentlemen, this concludes today's call.

You may now disconnect.