Arista Networks Inc (ANET) — Q4 2015 Earnings Call Transcript

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 fourth quarter and year ended December 31, 2015. If you would like a copy of the release, you can access it online at the company's website. During the course of this conference call, Arista Networks management will make forward-looking statements, including those relating to our financial outlook for the first quarter of the 2016 fiscal year, industry innovation, our market opportunity and the impact of litigation, which are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically in our most recent Form 10-Q and Form 10-K and which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. Also, please note that certain financial measures we use in this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. We have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in our earnings press release. With that, I will turn the call over to Jayshree.

Thank you, Chuck. Thank you, everyone, for joining us this afternoon for our 2015 and Q4 earnings call. I am pleased to report that we had a spectacular year with a strong finish. Annual revenue grew 43.4% year-over-year to a record $837.6 million while earnings per share increased 52.8% to $2.44. This was driven by our innovative platforms, differentiated EOS stack and CloudVision orchestration. Services contributed 11.1% of overall sales as cloud demand fueled our growth across our top verticals, especially the cloud titans. From a geographic perspective, our customers in the Americas contributed 76.8% of total revenue in 2015 as our international theaters progressed steadily. We delivered non-GAAP gross margins of 65.3% for the year as we grew profitability in a highly dynamic and competitive industry. We are now in excess of 3,700 cumulative customers, including new customer upticks and expansion from our existing customer base. Microsoft was 12% of our 2015 revenue, symbolic of the continued shift we see from on-premise enterprise to workloads in the public cloud. We remain fully committed to significant R&D and customer support investments, often in conjunction with our key technology partners to bring open, industry-wide cloud conversions. Let me quickly recap some of our 2015 highlights. Early in the year, we announced 26 new leaf and spline platforms for 10, 25, 40, 50 and 100 gigabit ethernet, all based on our single binary image EOS philosophy, utilizing diverse silicon architectures. In May 2015, we achieved the coveted leaders quadrant with one other vendor in Gartner's Magic Quadrant for data center networking out of the 11 vendors mentioned. We forged a key agreement with HP for the conversion for the structure of compute and storage integrated by HP OneView and Arista EOS. We introduced a revolutionary platform, CloudVision, for workload provisioning and workflow automation, offering interoperability across overlays like VMware NSX as well as integration into Dell, HP and OpenStack frameworks. Later in the summer, we extended CloudVision to security with Macro-Segmentation Services, or MSS for short. Holistic security is a top-of-mind customer mandate, and we are working well with security visionaries like Palo Alto Networks, Check Point, F5, Fortinet and VMware to realize it. In fall of 2015, we launched our media and entertainment initiative with industry leaders, transforming the once analog world to a highly digitized, software-defined and IP one. In November of last year, we delivered our first spine Internet booking solutions connecting between data centers with Layer 1, Layer 2 and Layer 3 options endorsed by our leading customers: Box, Equinox and Netflix. Earlier this year, in January of 2016, we announced a foundational Arista EOS infrastructure with NetDB, a network-wide, state-oriented database. NetDB builds upon our core state architecture by adding network-wide actions including state-sharing mechanisms for control, replication, rollback and streaming analytics. We also announced use cases for hybrid cloud, Docker container support and more programmability models with OpenConfig and Go. All of these are compelling examples and alternatives to the traditional world we all live in. Demonstrably, we have had a busy year, growing our employee strength to over 1,200 with worldwide investments across 70 countries and 120 support people. And as we enter the new 2016 fiscal year, we believe we are gaining market share and increased relevance in the cloud networking segment. We are the only authentic state-based cloud stack, differentiated from mega-scale networking. Others may mimic us with marketing, buzzwords and architectures. We simply execute and deliver. We believe our publish-subscribe-notify is simply several years ahead of the industry, and I couldn't be more proud of our customers' steadfast acceptance of Arista as well as our team's results. Now I will turn it over to Ita for Q4 and 2015 financial details.

Thanks, Jayshree, and good afternoon. We reported legal costs related to ongoing lawsuits and the release of a tax gap reserve mentioned in the previous quarter. A complete reconciliation of our selected GAAP to non-GAAP results is available in our earnings release. Total GAAP revenues for Q4 were $254.4 million, reflecting a 41% increase year-over-year and exceeding our guidance of $238 million to $242 million. For the year, revenues reached $837.6 million, up 43% from the previous year. As we expected, our cloud titan vertical showed significant strength in the fourth quarter, along with solid contributions from other key verticals. Service revenues continued to rise, making up 11.5% of revenue for the quarter, up from 11.1% in Q3. International revenues were $47 million or 19% of total revenue, down from 22% last quarter. We saw continued growth in EMEA, balanced by some variability in APAC. Our overall gross margin for Q4 was 64%, consistent with our guidance of 62% to 65% and reflecting a shift in revenue mix toward the cloud titans. Operating expenses for the quarter were $85.7 million, compared to $83.1 million last quarter. Total spending grew 3% quarter-over-quarter, significantly slower than our 13% topline growth. R&D spending decreased by $1.5 million due to lower-than-expected variable and prototype spending. Sales and marketing expense rose to 11.4% of revenue, reflecting increased headcount and higher variable compensation costs during the period. Our operating income for the quarter was $71.3 million or 29% of revenue. Other expenses totaled $0.9 million, and the effective tax rate was 18.5%, leading to a net income of $57.5 million or 23.4%. This tax rate reflects the full benefit of the renewed research and development tax credit for 2015. If excluding this effect, the non-GAAP effective tax rate for the quarter would have been 30.4%, resulting in non-GAAP net income of $49.1 million or 20%. Our diluted share count for the quarter was 72.1 million shares, which resulted in a diluted earnings per share of $0.80, up from $0.59 in the prior quarter and a 50% increase from the previous year. This EPS includes a $0.12 benefit from the research and development tax credit renewal. Legal expenses related to ongoing lawsuits were $9 million for the quarter, slightly below our outlook of $10 million from the last earnings call. These expenses are not included in the non-GAAP results mentioned earlier. Turning to the balance sheet, cash, cash equivalents, and investments at the end of the quarter totaled $687.3 million. We generated $117 million in cash from operations during the December quarter, an increase from $10.6 million in the prior period. DSOs were at 54 days, compared to 68 days in Q3 and 57 in Q2, thanks to significant process improvements. Inventory turns were 3.2 times, an increase from 2.6 in Q3, and inventory decreased to $92.1 million, down from $110 million previously, due to a heightened focus on inventory management. Our deferred revenue balance rose to $197 million from $191 million in Q3 and primarily consists of short- and long-term service contracts, with some product deferrals due to acceptance terms. Accounts payable days were 45, up from 38 in Q2, reflecting the timing of inventory receipts and payments. Capital expenditures for the quarter were $5.3 million. Looking ahead to the first quarter, we are pleased with our 2015 financial performance, with revenues up 43% and earnings per share up 58% year-over-year. As we consider 2016, we believe the fundamentals of our business remain robust. Workloads continue to move toward the cloud, benefiting our key customers who are deploying our differentiated products in their data centers. It’s typical for us to see subdued activity in the first quarter as customers complete their budgeting and planning processes. Based on our current outlook, we expect first-quarter revenues in the range of $232 million to $240 million, showing a slight decline from Q4 2015 levels but still reflecting year-over-year growth of 30% to 34%. Our revenue mix is anticipated to remain heavily weighted toward our cloud titan customers, and we expect gross margins to be in the 62% to 65% range. Therefore, our guidance for the first quarter, based on non-GAAP results and excluding any non-cash stock-based compensation and legal expenses associated with ongoing lawsuits, is as follows: revenues of around $232 million to $240 million, a gross margin of about 62% to 65%, and operating margins of approximately 26%. Our effective tax rate is expected to be between 28% and 30%, with diluted shares of around 72.5 million. Currently, we anticipate lawsuit-related costs to be around $9 million for the quarter. With that, I will turn the call back to Chuck.

Thank you, Ita. We are now going to move to the Q&A portion of the Arista earnings call.

Jayshree, I wanted to start out with kind of the cloud vertical. Obviously, you had a strong showing here in Q4 with the cloud titans. You're guiding to another strong quarter in Q1. We've seen other companies on the enterprise side, specifically Cisco and NetApp, start to see a little slowdown in the enterprise side. So one, what's your view on the strength and the visibility and the continued strength in cloud this year? And could you offer any sort of visibility, what you're seeing on the enterprise side as well?

Thank you, Brent. Well, I'm no macroeconomy expert, so I'll leave that to the pundits. But in our micro cloud world at Arista, we continue to see strength in the marketplace. Cloud titans had a strong quarter in Q4, and we expect to see that in Q1 and beyond as well. I'm especially encouraged by the rapid shift we are witnessing of enterprise workloads to private, public or hybrid cloud. So I think the cloud economy trend is pretty inevitable to me, and I see that in 2 forms. I see that as hybrid cloud implementations in the enterprise and, obviously, public cloud implementations, where Arista provides product today to our cloud titans. All 4 verticals did well, but clearly, the cloud titans did better. But I would say the other 3 were strong and grew well, too.

I just wanted to ask specifically about Microsoft, if it managed to hit 10% of revenue for 2015. And if so, if the math is right, it was down a few million, in line with the guidance you gave heading into the year, flat to down at Microsoft. What's the outlook specifically for Microsoft for 2016? Should we expect it to be 10% or more of your revenue into 2016?

Thank you, Stan. So just, first, a little quick review on history. Microsoft has always been our top customer with greater than 10% concentration. I believe in 2013, it was in the 20s. In 2014, it went down to the teens. And in 2015, we're now at 12%. So as a percentage of total revenue, it's steadily going down. As actual numbers, it continues to be important and is actually steadily going flat to up. And we fully expect 2016 to be an important spend year for Microsoft. I think it'll continue the trend down in percentage but remain relevant in actual revenue contribution.

Just wanted to get a sense here. Could you talk a little more about the cloud penetration with respect to the cloud titans in terms of not only the cloud providers but also those who are doing their own private or hybrid cloud on their own? If you could talk about how the penetration runway looks there. And then bigger picture, your numbers obviously speak to themselves in terms of the strength you're seeing, but investors are going to start thinking about what's next. And so how should investors start thinking about Arista in terms of moving into routing over the next few years? And what that revenue contribution could look like over time?

Thank you. I think it's important to recognize that our cloud penetration is still in its early stages. While we may not be at the very beginning, we're certainly not far along; there's still significant potential for growth. Many infrastructures are just starting to expand, with most developments occurring in the last couple of years, which leaves ample space for advancement. There is also room for all major cloud providers to explore new possibilities. We have collaborated with companies like Facebook, Wedge, and OCP designs, as well as with Microsoft's open switch architecture. Additionally, we've worked with other significant players in the past who developed switches even before Arista was established. We are confident that our approaches can coexist, and the total addressable market is so vast that various configurations will always be present. Our focus will increasingly shift towards creating a top-tier universal spine, and at times we may work with our own Arista leaf or with other leaves in the network. We see substantial opportunities for growth in our market penetration alongside internal development. Looking ahead, it's crucial to note that our main market is the data center cloud, which has a huge addressable market. In 2015, the total market was estimated to be around $8 billion, and we are currently reporting $837 million, indicating there is a lot of potential for expansion. It's essential to keep this in mind. Regarding routing, we have been involved in Layer 3 routing for a considerable time, and we anticipate further developing our BGP scale and Internet cable routes. We are optimistic that traditional core routing will evolve into the new spine, allowing us to incorporate more functionalities as features of our spine. This is a great opportunity for service providers to reduce their capital expenditures, with Arista providing additional operational expenditure savings as well.

Do you have any comment on the case with Cisco? And specifically, since the ITC judge's initial determination came out just a few weeks ago, if the tone of conversation with your clients has changed at all? Are they at all more cautious?

I'll take a bit of it, and then I'd love to have our expert and GC, Marc Taxay, my good friend, comment more. First of all, Arista is always happy to address specifics in the courtroom, not in sensational blog rooms. But having said that, our primary focus, as you rightly point out, Steve, has been our customers. And their support to us has been unwavering. Our goal has been to offer them appropriate design workarounds with nonintrusive upgrades, and they are very comfortable with our plans. And they are very supportive of what we are doing and how we are working with them. Marc, do you want to add some more?

Sure, Jayshree. Just to briefly update everyone on the status of the investigation. As you point out, starting with the 944 investigation, the administrative law judge did issue an initial determination in that case on February 2. As a reminder, that case originally had 6 patents in it, 1 was dropped, so there were 5 remaining. Of the 5 remaining patents, 3 of them, the judge found that we infringed and 2 he found that we did not. It's important to note that of the 3 patents that were in question, they actually relate to only 2 features. The first addresses the manner in which our agents communicate state to SysDB, and the second relates to our implementation of private VLANs. We've said this before, and we'll repeat it here, Cisco is not asserted, and the judge didn't find in this case, that EOS contains any Cisco code. It's also important to note that PVLANs is a common feature that's offered by nearly all network switch vendors today. Going forward, we're seeking commission review of the infringement findings in the initial determination. The ITC will consider our arguments as well as Cisco's and issue its final determination on June 2. If the ITC finds a violation and issues remedial orders, that then goes to the U.S. Trade representative, who will consider whether to veto those orders during the 60-day presidential review period. That period will end on August 2. We're going to continue to make our case to the ITC, of course. And as a mitigation strategy, we're also going to be in the process of developing technical workarounds for these patents, as Jayshree mentioned. We are very confident in those workarounds. And if the ITC does issue an exclusion order as part of this process, we'll seek to obtain customs' approval that the workarounds are outside the scope of the orders in order for us to continue the uninterrupted importation of products. This will be a time-critical exercise needing strong execution. Of course, Arista will respect the final determination of the ITC. If the final determination is adverse, we'll work in good faith to implement the workaround so that, to the best of our knowledge, all products supplied to customers will be non-infringing. Now with respect to the 945 investigation, that's still under review by the ALJ. The administrative law judge will issue her initial determination on April 26. That decision will then be subject to review by the commission, and we expect for them to issue a final determination and any remedial orders for that case on August 26. That then goes to the presidential review for the 945, and it would end on October 26.

Thank you, Marc. I feel like I have a PhD in ICT.

Alex?

I wanted to squeeze 2 in. Maybe just first you can comment on where you are in the development of the workaround and your confidence in your ability to get those built and approved by the end of Q2. And then for Ita, I was hoping to touch upon margins as expenses came in quite a bit lower than we expected, and you're guiding operating margins to higher levels than we've seen you guide for the last several quarters even though there hasn't really been a change to gross margin forecast. So I was just hoping to understand if you feel like 26% or better is likely to be a sustainable operating margin level going forward? If you think you can make all the needed investments to support your growth at those levels, or if we should expect operating margins to dip as we look out towards Q2 and the second half of 2016?

Yes. I mean I think if you look at the approximately 26% operating margin guidance, it's pretty consistent with last quarter as well, right? And I think the way to think about that is as we ramp spending and make the investments that we need to make, we're doing everything that we need to do from an investment perspective. But revenues are growing at a pretty fair clip, right? And we're being very judicious in how we spend money. And sometimes, the revenue is going to grow faster, right. And that will result in some upside to that. I think our guidance takes a view of, here are the possible things that we need to go do in the quarter, and that's kind of reflected in that 26%. I think in terms of a long-term model, we've talked about maybe a 25% operating margin being a reasonable way to think about it, and that gives us scope to grow sales and marketing expense as a percentage of revenue a little bit and maintain our investments in R&D. So I think that's how to think about it. I don't know if the 26% is anything new necessarily. And probably, long term, it's like a 25% operating margin model.

Thanks, Jess. We have been planning and exploring various scenarios. Although we believe we have not infringed on these patents, it is important to be prepared. Our engineers have been diligently working over the past year, so we are confident that we have identified workarounds for the 944 case, which should be ready by Q2. Marc, do you have anything to add?

Yes, I think that's right. Our team has been diligently working and continues to assess everything. We are in the process of releasing a new version of the software, which will be available in Q2.

So I have two quick questions to further discuss the legal situation. Ita, did you adjust the methodology related to guidance to account for any disruptions linked to legal issues? That's more of a clarification. The second question is about another significant cloud customer, Facebook. They've expressed their plans to develop EU2 completely powered by Open Compute. What role will Arista have in this, if any? Additionally, how might the relationship evolve over time?

I'll take the first part of that question. The guidance for Q1 is business as normal, right, with support of our customers and not really assuming any disruption from a legal perspective.

That's correct. That's exactly right. And your second question on Facebook, Ryan, we have said a number of times, we fully expect our cloud titans to also do engineering. It's not the sole responsibility of Arista. But in many cases, this is codevelopment. And in many cases, it's complementary. So I do think Facebook will use a lot of their capabilities. But it's core versus context. It's clearly core to Arista, and we provide a lot of capability. And then we work closely with Facebook's application to give them the right control, so I'm very comfortable that there's room and opportunity for both.

I'm going to try to sneak in 2. The first question, Jayshree, on Tomahawk-enabled switches, just curious to see if those are ramping in line or better or maybe even worse than expectations? And then the second question is really on the legal side. Any update on the antitrust claim that you filed against Cisco? And do you see that impacting the ITC or the District Court lawsuits in any shape or form?

Okay. I’m reviewing the Tomahawk data. The products are being well received overall, particularly by the cloud giants who are often the first to adopt this technology. This year is significant for Tomahawk, indicating strong acceptance of 10 gig, 40 gig, and 100 gig. However, we haven't seen the growth in 25 gig and 50 gig that we would like. There was a lot of discussion about it last year, but I believe this will be the year for 25 gig and 50 gig, which is important. Regarding the lawsuit, I'll let Marc address this further. My only point is that when a monopolist claims ownership of open standards, it not only negatively impacts Arista but also affects the entire ecosystem and hinders innovation. We prefer to focus on innovation rather than litigation. We’ve given this considerable thought, and Marc may want to explain our reasoning.

Sure. No, I think that's right. And I think we evaluated the situation, and we felt that based upon what we had seen that Cisco was engaging in a series of anti-competitive behaviors. And we initiated the action really to level the playing field so we can win in the marketplace based on the merits of our products. So we did initiate this filing. We filed, in the copyright case, in the district court a motion for a leave to amend our answer to the complaint that was originally filed to include the two counterclaims. The first claim alleges that Cisco is engaged in an illegal bait-and-switch with the industry and its customers to protect its monopoly position in switching and routing. We asserted in that, that Cisco has aggressively promoted its CLI as the industry standard to encourage customers to adopt and heavily invest in the CLI without having to worry about vendor lock-in or having to invest in training and scripting for alternative CLI commands. Our claims allege that when Arista achieved success in the marketplace that threatened Cisco's position, Cisco reversed course and now essentially is using those customers' investments against them to achieve vendor lock-in and protect its dominant market share by seeking to preclude competitors from using its industry-standard CLI commands, contrary to its past representations. The second claim alleges that Cisco uses its market position in switching to punish its customers for buying competing products by prohibitively increasing the prices it charges for servicing Cisco switches where the customer has indicated they plan to buy switches from Cisco's competitors. So what we've done is we filed the amended complaint. That's being evaluated by the court now. The court will make a decision as to whether or not we can include this as part of the existing action or whether or not we should be filing a separate action. We'll find out on that shortly.

Thank you, Marc.

Marc, we're going to keep going at this. In your prepared remarks, there were a couple of really important sentences that I heard about the timing of the workaround, and it sounded like there was some request for an exclusion of the workarounds as far as how the products could be continued to be delivered to customers until the workarounds were assessed by the court, something along those lines. Could you clarify that and maybe go through that again and what that means for revenue as we go through Q2, Q3, and Q4?

I don't think we mentioned anything on our prepared remarks. Can you clarify what you're asking?

Yes, Marc went into some detail in his prepared remarks, Jayshree, about the process of the workarounds as they go through the court. And I just wanted him to expand on that a little bit as far as the timing and what the gates you had to go through to get that approved.

Sure.

Sure. So as we said, we have been developing design arounds. And we're in the process of releasing a new version of EOS that will include that. The process for us would include seeking approval from customs in order for customs to ensure that we can import those products into the U.S., a non-infringing version of those products into the U.S. And so we'll initiate that process once the final determination from the ITC comes in. It's our view, of course, now we're still fighting this case. We're going to continue to fight it, and we've submitted our briefs over to the full commission. And then once the commission, if the commission issues an adverse ruling, at that stage will work with customs to try to go through the process as quickly as possible.

So just to be clear, we won't know anything about this until June 2, as Marc said.

I had a question for Ita and one for Jayshree. Ita, can you talk about the deferred revenue? The number did not go up as fast this quarter. And the question for Jayshree is that the software-only SKU has been out for some time now. Can you talk about what you are seeing in terms of demand for that software-only SKU? Are you seeing any increase in interest from the cloud titans or the web customers?

Yes, regarding the deferred revenue question, the balance will fluctuate from quarter to quarter. Our service renewals vary based on customer size and contract duration. Additionally, on the product side, it hinges on shipment timing. If we send products at the end of a quarter to a customer, the balance will be higher. Conversely, if we ship on the first day of the next quarter, it will be lower. Therefore, it won't follow the typical predictable cycle you might expect.

Yes, I think it's also fair to say, it could stay flat, it can go down, it can go up. I wouldn't read too much into that metric. It's not indicative of customer... And Rajesh, regarding your question on software SKUs, we've offered that a lot and talked about it a lot. But at the end of the day, we've seen that more of our customers want to know we have it but prefer to use our hardware and software together. So the actual success and implementation and deployment of this has been small. The discussion of it has been large. There is a disproportionate difference between implementation and discussion.

Just a question, talking about geographies, et cetera. You mentioned that Asia saw some lumpiness. And I'm just wondering if you could talk about how we should expect that and those other international geographies to develop? And I guess I'm looking at it in the context of the feedback that we have received from a lot of channels in international that it seems like Arista is having a hard time completely satisfying the demand in some of those newer geographies. So can you just talk about how we should expect these international geographies to develop? And what your sense is as to underlying demand trends, et cetera?

First of all, James, I believe we are performing very well internationally, though this is somewhat overshadowed by our strong performance in the United States. I want to emphasize that point. I'm particularly encouraged by our achievements in Europe, where we have recently appointed a strong leader with 25 to 30 years of experience in networking. We are seeing robust performance in especially developed countries like the Nordics, Netherlands, Germany, and the U.K. Asia, on the other hand, is not a single market; it includes Australia, Korea, Japan, and Southeast Asia, with a significant focus on India. As for China, our presence is relatively low, leading to fluctuations in our numbers from quarter to quarter based on the size of deals and wins. We experienced some large customer wins in Q2 and Q3 compared to Q4. Regarding the challenges we are facing, I think we are still in the early stages. I don't perceive it as difficulty; rather, we just started later. I would say our first significant year of international focus began in 2015. I fully anticipate seeing more progress, and one key indicator of success in the end market is the acquisition of new customers. We are actually witnessing greater acceptance from new customers internationally than in the United States, which indicates to me that the upcoming years will be very promising internationally.

Jayshree, could you clarify your comments about the Tomahawk-linked products and how you expect them to drive success? It seemed like your answer cut off. Additionally, regarding verticals, I'm curious about the breakdown between financials, the major cloud providers, and other service providers compared to how you previously discussed it. Are the revenue numbers from 2015 still looking balanced?

Yes, I believe I understood your question about Tomahawk, but let me address it again. If I don’t fully answer it, we can discuss it more in the follow-up call. We are pleased with the transition to Tomahawk, but it hasn't become mainstream yet. Trident, including Trident I and Trident II, remains the main technology. It's important to note that we have only had one quarter of Tomahawk in the market. While we introduced the products, the actual qualification, production, and installation have only been happening for this quarter. I see this year as the true indicator. Additionally, we haven't seen an immediate increase in demand because customers are satisfied with our current 10, 40, and 100 gig offerings, which meet their feature requirements and price points. The transition to Tomahawk will particularly require more demand for 25 and 50 gig solutions, which depend on a broader ecosystem—such as host adapters, NICs, compute, and storage—all needing to work together. Therefore, this year is more critical for Tomahawk compared to last year. Your second question was regarding...

Revenue breakdown vertical for 2015.

Yes, the verticals have remained the same. We continue to focus on our top four verticals. From our 2015 order of priority or success of the verticals, the first was clearly cloud titans. The second was service providers and Tier 2 cloud providers, while financial services and high-tech enterprise were tied for third place.

I wanted to just get a sense for your plans on growing the sales organization. Where are you in terms of sales force expansion at this point?

We're doing well. We could always be doing better. I think one of our sales models, if you look at it, which is different from others is Mark Smith and Anshul and Mark Foss, they're not focused on coverage. They are focused on our 4 verticals and what we call the Arista 100. We are looking to make an engagement that's both long-term and impactful and strategic, where they really want to transform the data center. So if it's a regular enterprise IT customer, they're probably less interested in Arista. Because they'll just keep buying what they are, and it will be hard to change old habits. And so our sales model is very much targeted on: Go deep rather than go wide, and really focus on a few good geographies and obviously the top 4 verticals than everywhere. And we are doing very well there. We've hired well both in sales and technical SEs.

Can you give us a breakdown of the size of the sales organization?

I don't think we've done that historically. But if I look from year-over-year, we've definitely increased by double-digit percentages.

I have a question, a return to a theme that you just hit upon, Jayshree, which is new customers. Can you help us maybe think through how much of your business each quarter or each year is driven by repeat orders and how much by new customers? And then the second part of that is, are there particular new customers or suites of larger new customers that you are excited about for 2016?

Yes, those are both very good questions, Jeff. I measure new customers closely, not because they significantly impact core quarterly revenue, but because they represent the potential for future growth. In terms of actual revenue contribution, they typically account for single to double-digit percentages. The initial orders from new customers are usually modest, often around 50K or 100K. Therefore, while we might have numerous new customers, that doesn't translate to substantial millions in revenue right away. The crucial factor to consider is what happens 6 to 12 months and 18 months later. That’s when these customers can evolve into significant million or multimillion dollar clients. So, we observe a new logo paired with a smaller project, followed by a more considerable achievement within 12 to 18 months.

So I've got 2 questions. They're both on the chip side of things. First off, has there been some delay in the timing of getting the Broadwell chip out from Intel? And has that slipped your timeline for the full architecture of 25 gig stack rolling out a little bit in terms of timing into the back half? And then the second one, along the same lines, can you give us an update on what you're thinking on the Jericho product coming out and when that might impact the router market? I mean, that's an $8.6 billion TAM that will roll into the switch market at some point when that gets going. Just give us an update on those 2?

Yes. No, thanks, Alex. They're both good questions. I think you're absolutely right to point out that the 25 and 50 gig NIC, and it's not just Intel, it's Intel, Broadcom. I think Mellanox plays in that. And there's a lot of onboard LAN on motherboard-type activity. All of that has not happened in 2015, and we fully expect them to happen in 2016. And I think one of the biggest drivers will actually be storage. As you move to more scale-out, flash-based storage, there will be less and less fiber-channel SANs and more and more Tier 2 IP storage SANs. And we think 25 and 50 gig is a pivotal performance to hit, while 1 and 10 gig may be more for compute. So you're right to point out that, that hasn't happened as fully and well and will in 2016. In terms of Jericho, the one thing I would just say in general about the silicon industry, since I came from this industry 30 years ago, is we always tend to overestimate the availability of a chip as opposed to the availability of a system. I think Jericho was announced by Broadcom a year ago, and we are very impressed with the table sizes and capacity and buffering and capability. But announcing a chip is very different than vendors announcing systems. I fully expect that systems will come into play in the summer of '16. And the qualification of those systems, because it's routing and spine, can take longer. So I think 2016 will be a year of trials for Jericho and core routing. And then the multibillion-dollar market you talk about will really be a multiyear execution.

First for Jayshree, what is your grand vision on Arista products and solution in the security space after the new release of the CloudVision? And second question will be for Ita, how much CapEx should we expect in 2016?

I'll take the first question, Ita. Security is a key focus for many of our customers, both in the cloud and in traditional enterprise networks. Arista doesn't consider ourselves security experts; we view that as a separate market that evolves with each new threat. Our goal is to collaborate with industry leaders and innovators in this field. One of our closest partners is Palo Alto Networks, and we are also engaged with Check Point, F5, Fortinet, and VMware. It's one thing to detect a threat, which our security partners excel at, but it's another to prevent a threat from spreading. This is where Arista adds value. Through CloudVision, we are developing methods to effectively manage firewalls, rules, and policies with our security partners, ensuring a comprehensive approach from physical to virtual environments and advanced telemetry. This way, we can address threats across the entire network, rather than just reacting to isolated incidents. If one system is compromised, we work to prevent the situation from worsening.

And then just on the CapEx, I mean we've been averaging about $5 million a quarter. Could you see that spike a little bit a couple million here and there if we add some capacity and stuff? Maybe. But it should stay roughly in that range.

I have a question on the 100 gig market. Is there any delay to the deployment of 100 gig because of the 25, 50 gig issues you discussed here? I understand that the technology also reduces the price for 100 gig. And the question is, if we should model slower ramp for 100 G as a result of what you're discussing?

Thank you, Tal. I don't think that's the case. The demand for 100 gig, particularly in the spine, is being fueled by the existing 10 gig and 40 gig deployments. This will increase further with 25 and 50 gig. Our customers are all getting ready for 100 gig spine, regardless of whether their current setups are 10, 25, 40, or 50 gig. Currently, the availability of 100 gig ports is indeed much lower than that of 40, 10, or even 1 gig. The major challenge for us and the industry regarding 100 gig is ensuring we can provide high capacity density at an appropriate price point, especially concerning optics. Therefore, the cost of embedded optics is more significant than the 25 and 50 gig considerations.

Can you clarify your comments on margins? A few quarters back, you indicated that gross margin would likely decrease nearly every quarter, suggesting a decline of about 100 basis points each quarter for four quarters. Now we are witnessing improved margins. Is your current commentary on margins connected to the delays or the slow ramp-up of the 25 and 50 G?

No, not at all. I would say, Tal, that our margins, we did drop to 64% in Q4. And it's much more tied to mix, customer mix and product mix. But we feel pretty good about the acceptance of both 40 gig and 100 gig last year, and we feel quite optimistic about the additional acceptance of all this, this year.

A couple of quick questions. Just, Jayshree, on the competitive front, have been there any changes in the posture of incumbents as they continue to experience share losses? And then secondarily, have buyers changed any of their buying patterns? Are there larger or smaller deals as we sort of close the quarter, are sales cycles any longer? Have you seen any changes on the buyer front?

That's a good question. Have there been any aggressive competitive changes? I think it's the same as always. When it comes to Arista, we see that we receive our share of aggressive competition, and it continues to be heightened. However, I wouldn't say there's any change; it's always been heightened and remains so. Have we seen any shift in behavior? Not yet, no. We are seeing strength in the cloud. We're not the experts on enterprise, but the enterprises we serve tend to be very knowledgeable and capable, thus may represent a smaller percentage of the broader enterprise market. However, in our specific Arista context, we haven't seen any dramatic changes.

Jayshree, Ita, my question is around the weakness we and others are noting in enterprise IT spending in particular. So this a bigger-picture question, which is, would you anticipate the big banks, the high-tech customers you sell into, asking for hyperscale price points that currently a Google or an Amazon would demand from their vendors? And if so, how would you manage margins in this more compressed ASP scenario, where enterprises are asking for hyperscale price points?

Vijay, yes, that's a great question. And my answer to pricing is always the same, whether it's a customer or you, which is if you show me the volume, I'll show you the pricing. So if we have large enterprise customers who can drive hyperscale volume, we'd love to achieve those price points. Because it gives us a chance to drive cost reductions and, therefore, price reductions. And so there are some enterprises who can do that, and there are many who can't. So I think it depends on the sector. Ita, do you want to add anything more to that?

Yes. No, I think that's exactly it, right? I mean it's very much a volume-based pricing model for us, right? So yes, if there's volume there, we can drive the pricing and the cost.

Excellent. I have a quick follow-up question. Should we consider the 100 gig Tomahawk switching opportunity as being more weighted towards the second half of the year? From what we've been hearing, most of the early volume involves small-scale, top-of-rack upgrades at certain web-scale data centers. It seems like the larger 100 gig spine refresh is mainly happening in the latter half. How should we view the timing of the 100 gig Tomahawk refresh in terms of second-half weighting compared to a more even distribution?

I think your thought process on this is very good, Vijay. I think the only thing I'd add to what you just said, and I agree with it, is I think the first half will be heavily weighted to planning 100 gig spine and also deploying as many leaves, whether they're 10, 40, 25, or 50. People don't think as hard about the deployment of leaves because they view them as disposable items. They have shorter depreciation cycles. And so I see that the 100 gig spine has definitely started already and will continue to increase in the summer and second half. But I don't necessarily see that as Tomahawk, I also see that as spines based on our Arad technology, leading to Jericho in the future.

First, I would like to clarify something. The R&D expenses in December were slightly lower than our projections from the previous quarter. I want to know if there were any one-time or timing issues that might affect the March quarter in relation to R&D. Additionally, I would like an update on whether we can quantify the progress of your partnerships. You mentioned the converged partnership with HP today, and you have previously discussed VMware. I'm looking for a way to evaluate the progress or provide an outlook on these partnerships.

Yes, just to take the R&D question, I mean that does move around a little bit just based on variable spending, prototypes, NRE, that type of stuff, right? So there's nothing unusual happening there, just really timing of those 2 activities.

Simon, I would like to provide a more detailed answer in the upcoming quarters. I believe HP, VMware, Palo Alto Networks, and our partnership with Docker are all examples of how we are effectively marketing technology and transitioning from traditional networking to modern converged or cloud networking. We haven't effectively communicated our successes and metrics in this area, and we owe you more clarity on that. We've mainly focused on business development and marketing, and we want to ensure customers understand that. I am particularly pleased with the successful integration we are witnessing with NSX and Arista, and we are seeing more of that now compared to a year ago. However, let's revisit that question when I can offer more concrete insights.

Okay. You know I'll hold you to it, too.

I know. I'm afraid of that. I owe you.

Jayshree, I have a couple of related questions. They're really connected. First, I understand you're hesitant to provide a detailed breakdown between the cloud giants and other sectors. However, given the significance of this issue from various angles, I hope you can share more specifics rather than just stating they are your largest switches. Can you at least tell us if they constitute closer to 50% of revenue or more like one-third?

None of our 4 verticals are anywhere close to 50% of our revenue. They average in the teens to the 25%. That's the averages.

So you're all right. Well, the...

I answered your question.

You obviously need to have a vertical that exceeds 25%, unless they are all at 25%.

No, that's not always the case. You can have one of them peak over 25% in a given quarter. However, over a year, I want to clarify that just because we have four verticals doesn't mean we don't have anything beyond those four either.

Well, I'm clearly talking in the context of where you guys break out revenue when you're talking of 4 verticals in that context.

I think I've done my best to help you out by saying while we do not want to get in the practice of breaking verticals out, none of them or any of them are anywhere close to approaching 50%.

Yes, I think it has been pretty stable. It is a significant part of the business, without a doubt. I am not sure if we have provided the exact percentage, but it has been a substantial part of the business. Looking at it over the last 2 to 3 years, it has remained stable.

It hasn't changed.

It has been pretty stable.

All right. I appreciate that. You're telling us cloud at most is 25% or thereabouts. All right. Let me move on. I'm not sure if you've done it recently, but you used to tell us your 10 largest customers on an annual basis back in '13, if I have the numbers correct, it was 43%. Can you give us an update on that? And then I've got a pricing question.

No. I think the only 10% concentration customer we reported in '14 and...

I guess I wanted to go back to the international business. If I look at it in absolute dollar terms, I think it's been roughly flat for about 3 quarters. And obviously, it's a big percentage of the addressable market. Can you just kind of walk through what you're doing sales and marketing-wise to kind of get that business growing again? And is there some intuitive reason why it has been flat these last couple of quarters despite the larger business really growing?

I think just to clarify the numbers, George, I think EMEA has actually been growing quite healthily for us, and it has been keeping pace actually with the overall business. APAC, I think, to Jayshree's point, it's still at the stage where if we win a big opportunity in a particular country, it's going to change that dynamic a lot, right? So I think about it in 2 phases. EMEA is more developed, and it's more consistent. And we are seeing success there. And then APAC is still a little bit more opportunistic, and we've got more work to do there.

Yes. No, I think it was well said, Ita. I think we've got a lot more volatility in APAC, and we've got more work to do there. In EMEA, I think our numbers have been steadily growing. Sometimes our numbers look higher if the placement of our cloud titans is in a particular geography in Europe, which is not really organic growth, but it reflects in our numbers. But I think in general, U.S. and EMEA have been growing, and APAC has been volatile and lumpy.

I wanted to follow-up on the earlier discussions around Facebook and Microsoft, recognizing that there are some internal projects, but that you're still going to continue to sell to them. In aggregate, would you expect your business with them to be up or down this year to the extent you have visibility? And then related to that, would you expect any other customers outside of Microsoft to cross the 10% mark this year?

Simona, I'll take your first question, which is, no, I don't expect any customer to top 10% this year, but I expect them all to be big customers. Specific to Facebook and Microsoft, your question was...

This concludes the Arista Q4 2015 Earnings Call. I also want to mention that we have posted a presentation which provides additional perspective on our 2015 fiscal results, which you can access on the Investors section of our website. Thank you to everyone for joining us today.