Arista Networks, Inc. (ANET) Q2 2015 Earnings Report, Transcript and Summary

Welcome to the Second Quarter 2015 Arista Networks Financial Results Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded and will be available for replay from the Investor Relations section of the Arista website following this call. I will now turn the call over to Mr. Chuck Elliott, Director of Investor Relations. Sir, you may begin.

Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me on today's call are Jayshree Ullal, Arista Networks President and Chief Executive Officer; and Ita Brennan, Arista's Chief Financial Officer. This afternoon, Arista Networks issued a press release announcing the results for its fiscal second quarter ended June 30, 2015. If you would like a copy of the release, you can access it online at the company's website. During the course of this conference call, Arista Networks' management will make forward-looking statements, including those relating to our financial outlook for the third quarter of the 2015 fiscal year, industry innovation, our market opportunity and the impact of litigation, subject to the risks and uncertainties that we discussed in detail in our documents filed with the SEC, specifically in our most recent Form 10-Q and Form 10-K, and which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. Also, please note that certain financial measures we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. We've provided reconciliations of these non-GAAP financial measures to GAAP financial measures in our earnings press release. With that, I will turn the call over to Jayshree.

Thank you, Chuck. Thank you everyone for joining us this afternoon for our Q2 2015 earnings call. I'm pleased to report our fifth consecutive beat as a public company. Consistent with prior quarters, customer demand for our 7000 Series EOS-based platform drove results that exceeded the consensus. From a geographic perspective, our customers in the Americas generated 77% of our sales and 23% was generated internationally from EMEA and Asia Pacific. We are witnessing continued traction with financials and modern enterprises and significant contribution from many of our cloud titans and service providers. Revenue grew 42% year-over-year to a record $195.6 million. Service contributed more than 10% of overall revenue. We delivered non-GAAP gross margins of 65.8%, resulting in a non-GAAP earnings per share of $0.54, growing 50% year-over-year in our competitive and dynamic industry. We now have over 3,390 customers and continue the acquisition trend of 1 to 2 new customers per day. This quarter, we had many key highlights. We announced a transformational network-wide state-based management platform called CloudVision. CloudVision is a very meaningful entry into software-based subscription services offering a network-wide operational control. It dramatically improves network change control for many of our customers. CloudVision offers a unique array of capabilities differentiated by a single point of workload integration, network-wide rollback and workflow automation and visibility. We do expect the results of CloudVision to be a multiyear journey and much more measurable in 2016 and 2017. CloudVision has been endorsed by many of our new and existing partners, including VMware, NSX, Microsoft, Hyper-V and Windows Server, HP, Dell, F5, Infinera, Palo Alto Networks, Nuage, Rackspace and Supermicro. Speaking of partnership, we formalized our converged infrastructure solution with HP for Cloud-Class Networking with HP's compute and OneView integration. We believe this is an important step not only for us, but the industry in moving towards converged solution for mainstream enterprises. We have now surpassed 5 million cloud networking ports in cumulative overall shipments. Our first million ports, to put this in perspective, took about 4 years. Our fifth million port was achieved in approximately 1/10 that time. We are therefore forecasting a cumulative revenue that will exceed in excess of $2 billion by the end of this year as we continue to feel good about gaining market share and customer relevance in our 10, 40 and 100 gigabit Ethernet data center market. Now I would like to turn the call over to our new CFO, Ita Brennan, for further financial details. Welcome, Ita, to your first earnings call with Arista Networks.

Thanks, Jayshree, and good afternoon. I'm pleased to announce the results for the second quarter of 2015, my first quarter with Arista. This analysis of our Q2 results and our guidance for Q3 '15 is based on non-GAAP and excludes all noncash stock-based compensation expenses and legal costs associated with the ongoing lawsuit. A reconciliation of our selected GAAP to non-GAAP results is provided in our earnings release. Total GAAP revenues in Q2 were $195.6 million, up 42% year-over-year and comfortably above our guidance range of $183 million to $191 million. We experienced good momentum across all key verticals in the quarter, and we're pleased to see our service revenue continued as a model percentage of revenue. International revenues totaled $45 million or 25% of total revenue. While we are focused on expanding our international footprint, you should expect our geographical revenue mix to fluctuate on a quarter-over-quarter basis depending on the timing of U.S. and international deployment. Although not impacting our financials at this point, CloudVision has demonstrated some good early market acceptance in the short time since our product launch, and we expect to see good traction into 2016 and beyond. Overall gross margin in Q2 was 65.8%, down slightly from Q1 at 66.1% and just above the upper end of our guidance range for the quarter. As a reminder, the biggest driver of volatility in our gross margin number is customer mix and to a lesser degree, product mix with large customers earning higher discount level. While our 4 verticals were well represented in our revenues for the quarter, we also experienced good traction with several of our cloud titan customers. Operating expenses for the quarter came in at $74.7 million or 38% of revenue, up 33% from the prior year and 11% from the prior quarter. Our spending increases were largely focused on additional personnel in sales and marketing and R&D, higher prototype expenses and additional consulting costs as we complete our first year of SOX compliance. Our operating income for the quarter was $54 million or 27.6% of revenue. Other expense for the quarter was $0.4 million, and our effective tax rate was 27.6%, resulting in net income for the quarter of $38.8 million or 19.8%. Our diluted share number for the quarter was $71.2 million, resulting in diluted earnings per share number of $0.54, up from $0.50 from the prior quarter and up over 50% from the prior year. Legal expenses associated with the ongoing lawsuits came in at $9.9 million for the quarter, in line with our outlook on the last earnings call. As a reminder, these expenses are excluded from the non-GAAP results discussed above. Now turning to the balance sheet. Cash, cash equivalents and investments ended the quarter at $552 million. We generated $52.6 million of cash from operations in the June quarter, up from $20.8 million in the prior period. DSOs came in at 57 days, flat to last quarter. Inventory turns were 2.7x, down from 2.8x in Q1. At the end of Q2, we held approximately $100 million in inventory, including $28 million of raw materials. Our inventory planning strategy is to leverage inventory [indiscernible] where needed to ensure that we can flexibly respond to our customers' needs. That said, this will be an area of increased focus in coming quarters as we look to improve our inventory metrics. Our deferred revenue balance was $164 million, up from $133 million in Q1. This balance is largely made of short and long-term service contracts with some product deferrals related to acceptance terms and future deliverables. Accounts payable days was 59 days, up from 43 days in Q1. Capital expenditures for the quarter were $3.6 million. Now turning to our outlook for the third quarter and beyond. We are pleased with our financial performance in the first half of 2015 with revenues up 47%, and earnings per share up 75% on a year-over-year basis. We continue to increase our market share and gain traction across key verticals and customers. The market remains competitive from a pricing perspective, and as mentioned above, our gross margins will fluctuate depending on our customer mix. We will continue to invest in the growth of the business, both in terms of increased headcount and the build-out of infrastructure as we expand our worldwide presence. We will do this in a judicious and powerful manner and within the parameters of our business model, which calls for operating expenses of approximately 40% of revenue. With this as a backdrop, our guidance for the third quarter, which is based on non-GAAP results and excludes any noncash stock-based compensation expenses and any legal expenses associated with the ongoing lawsuits, is as follows: revenues of approximately $208 million to $212 million, gross margin of approximately 53% to 65% and operating income of approximately 25%. Our effective tax rate is expected to be 28% to 30%, with diluted shares of approximately 71.7 million. Please note that based on our current understanding, we expect that the cost associated with the ongoing lawsuits to be approximately $15 million for this quarter, with this quarter representing a peak expenditure quarter as we engage directly in trial activities. I'll now turn the call back to Chuck. Chuck?

Thank you, Ita. We're now going to move to the Q&A portion of the Arista earnings call. We're expecting a lot of great questions. [Operator Instructions] Thanks, all.

[Operator Instructions] Your first question comes from the line of Subu Subrahmanyan with The Juda Group.

Jayshree, if you can talk a little bit about customer mix and product mix. You mentioned all 4 verticals were strong. Were there any particular standouts between the segments and between -- similarly between modular and fixed form factors? And then the other question I had was on carrier. Can you talk about carrier opportunities? How they're playing out this year with Tier 1 telcos and what the applications there may be?

Right. Thanks, Subu. First of all, on the vertical mix, we were very pleased with the balance of all 4. The cloud titans were the top performer, followed closely by the service providers and Tier 2, Tier 2 cloud hosting providers. But I would say, the financials and high-tech enterprise are holding and growing very nicely as well, so all 4 verticals performed in a balanced fashion. Our top 10 customers included customers from all 4 verticals. Specifically, in terms of carrier, as you well understand, carrier cycles are extremely long. It's a process we expect to be multiyear. We're getting early acceptance in the Tier 2 carriers. We're starting to make small inroads in the Tier 1 carriers as well, but nothing we would comment on or describe immediately since they're multiyear journeys. In general, I would say, the mix between modular and fixed remains similar. We've always said that leaf or fixed is, in terms of product mix, about half and then the modular and the optics and associated accessories is the other half. And we continue to see like the most well-accepted sign in the industry and the reception has been very good and continues to be good.

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

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

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

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

Thank you, Jeff. As far as we can tell, our TAM is still extremely big and we're less affected by macroeconomic situations and paces. Specific to the data center, in the 4 verticals I referred to, we're seeing good pace in all 4 of them. I would highlight that cloud titan as particularly high pace for 2015 in general for the first half, and we continue to remain positive about the second half as well.

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

Jeff, I've always said our visibility is short term with -- especially the cloud provider, so we never know beyond a quarter or 2. So I can't say about next year, but I feel good about this year.

Your next question comes from the line of Alex Kurtz with Sterne Agee.

Jayshree, can you just remind us about how you think about longer-term gross margin targets relative to the cloud titan mix as that grows as a percentage of overall revenue? You guys have continued to execute pretty well in the margin line here, and the cloud titan there is obviously the #1 vertical. So is there a magic mix level where they get the 40% to 50% of revenue and you would really expect to see the margins get impacted by that? Or maybe the pricing isn't so bad with that group of customers?

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

Yes, glad to be here.

Yes, good to have you here. What we've said in the past when maybe you didn't cover us is there is a big difference between the gross margin from our cloud titans and the rest of the customers, and the driver is really volume. Our cloud titans drive significant volume and pricing to our customers, and therefore, gross margin is very much driven by volume. So there is a delta of at least double-digit points between our -- the gross margin we tell you guys about and share with you and what they can be with the cloud titan. So obviously, lower in case you thought they were higher, by the way. So that continues. Having said that, we've also -- coupled with that, we also believe that we are going for footprint and market share, and there are a number of transitions going on. There's a number of competitive things goings on. The transitions going on is 1 to 10 gig in the leaf and then also 10 to 40 and 100 gig in the spine. We also see many transition that will come up next year for 25 and 50 gig. So speed transition means you have to drive the speed at higher speed at lower price, and that can have an impact on gross margins because you're trying to provide better price performance, so that's always the case. And then as we go for a race to footprint, we would look to gain market share and not always pay perfect attention to our market share. So while our gross margins -- all this as a backdrop to say that while our gross margins today have -- are in the 65%, they have come down from last year, 67%, and we project our long-term gross margins to be more consistent with the industry gross margins of 60% to 65%. Obviously, in that process, we hope we'd also gain share and grow to be $1 billion and multibillion dollar company.

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

Jayshree, I have questions. Interested in hearing more about the transitions toward 25 and 50 gigabytes. So in terms of timing and then multiple round of transitions, like, what is your expectation and outlook for the transition?

Yes. Hendi, that's a good question. First of all, I think this is -- the 25 and 50 gigabit transition will take time. The spec only got finalized this year, and the chips are only coming into the marketplace really effectively 2016. So the company, Arista, has been through 7 product transitions in literally 7 years. So we're very comfortable that the 25 gig and 50 gig is another speed transition, but very similar to a lot of our leaf product transitions we've done already in the 10 gig space or in the 40 gig space. So we don't see this as a dramatic event, but a natural, if you will, progression event of price, performance and speed. Where we think this will -- 25 and 50 will have more impact is especially for storage application. I think general-purpose compute can and will remain at 1 and 10 in many cases, and then the high-performance storage may have a great desire for 25 and 50. In terms of the spine, we think the major spine components will be 40 and 100. So there's room for every application, if you will, and every feed, and that's why we're doing so many of them.

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

Just quick follow-up on the margin question. You've made it clear, Jayshree, that we -- that you intend the and expect that the gross margin will come down to be more like industry averages. On the other hand, you've historically looked at being close or below the 25% operating margin level, but this quarter, you're guiding for that level. Do you think the 25% is kind of the -- should be the new long-term benchmark? Or is there something anomalous in this quarter that you're a little more confident on that? And then I wanted to ask from a business development standpoint, if the HP partnership and go-to-market work that you're doing there has started to have an impact. And how you're thinking about that and its opportunity to increase your addressable market going forward?

Thank you, James. I'll take the second question first, and then, Ita, if you don't mind, I'm going to pass the first one, especially the 25% operating margin and gross margin to you. I couldn't be more pleased with the HP partnership. It's one we've been working on for several months before it came to fruition. And HP, as you know, is not a company that would do this without thought. The converged infrastructure in this market is changing rapidly. It's changing for compute. It's changing for storage. It's changing for networking. And quite frankly, it's a market that Arista has not played in. We could not have played in it without a major market partner like HP. HP is a leader in compute and storage. This is an acknowledgment of a best-of-breed network partner by HP. We're working very nicely in the converged infrastructure and really providing solutions of scale and high availability. We announced this partnership in HP Discover, I think, it was in June, right? So we've had about 4 to 6 weeks here now, and the pipeline and traction has been exciting. We've already had single-digit customer wins, and so I'd say it's a good start, but a long ways to go.

And James, just to come back on the gross margin question. I think if you think about our long-term model in that 60% to 65% range, but as you'll see, our kind of near-term guidance, we're still sticking to the 63% to 65%. I think that's because we think that lower end of that range probably happens over multiple years. And obviously, in that time frame, we're also adding some capabilities, stuff like CloudVision, services growth. We'll see how all that plays out, but clearly, there's some puts and takes in both directions over time. So I think that's probably the way to think about it. In the near term, we're sticking to that 63% to 65%. In terms of operating margin, I think, the business model at 40% of revenues is still a good, solid way to think about it. We're growing into that, but we are making investments. We've investing in sales and marketing. We're investing internationally. I think 40% OpEx level is probably the right way to think about that piece of it.

Yes.

Your next question comes from the line of Sanjiv Wadhwani with Stifel.

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

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

Sure, I'd be happy to.

Thank you.

Thank you, Jayshree. So with respect to the ITC investigation, the schedule is as follows: the hearing for the 944 is going to begin on September 9 and continues through September 17. The hearing for the 945, the second investigation, will start on November 9 and continues through November 20. Our team has developed a good defensive strategy for the cases and were in the midst of preparing for trial today. We've also filed 7 IPR petitions, and we're currently awaiting the decision on those [indiscernible] as well. With respect to the copyright case, that trial date is set for August of 2016 of next year. We're also currently engaged in discovery for that case. As you recall, we also have the OptumSoft litigation right now. That has been bifurcated into 2 trials. The first will consist of a trial starting in September 14 of this year, where the court is going to determine ownership of the specific disputed software packages, and again, we developed a good defense for that case. And we're currently preparing for trial.

Thank you, Marc. That was good.

Your next question comes from the line of Ryan Hutchinson with Guggenheim.

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

Right. Thank you, Ryan. As you know, our strategy very much depends on excellent software running on different types of Merchant Silicon. Everybody gets access to the same Merchant Silicon. Arista has always been very unique in our ability to make that Merchant Silicon do unique things, whether it's with our drivers, our firmware, our customization, our deep understanding of silicon. We work with 3 types of silicon today. You pointed to one of them, Arad, which will be moving to Jericho. The Trident chipset, which has moved to T+ [Trident+], T2 [Trident II], name it; and also the Intel Alta chipset. And at any given time, we also have 1 or 2 others we're looking at. So Merchant Silicon and the life cycle and execution of those products and vendors is something we depend on, but we don't depend on only one architecture. We already have 3, and at any given time, we're looking at 2 others as well. So having been in the silicon industry many, many years ago, I can tell you I don't know a single chip that doesn't slip. And I can tell you there's not a single piece of software I know that doesn't have a bug. Those are just kind of normal ways of operating in engineering. So while it's not my place to comment on the expertise of those chips and why they slip, we do tend to accommodate that and generally doesn't affect our schedules and our product deliveries and our market plans because we account for them. And we always account for chip vendors having a metal spin or respin, et cetera. So in terms of addressing market, as Ryan, you and I have very much discussed, our total available market for the data center is $6 billion going to $12 billion. That is our primary and sole focus. Any adjacencies and additional things we do will come in the next few years, but we're not depending on them for chip or existing execution in our primary market.

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

First for Jayshree on the international mix. Can you share with us if the 23% of revenue from overseas customers included business with U.S. customers building out overseas and if you're starting to see incremental success with international accounts? And then for Ita, it looks like you saw a fairly large sequential and year-over-year increase in deferred revenues. So I was hoping to better understand some of the dynamics there. To what extent this reflects some short-term business that may have pushed out from Q2 to Q3? Or if it's all services, any additional input there would be helpful.

Thank you, Jeff, for the good wishes. We're pleased with the international progress this quarter. So first, to clarify, the numbers I gave you were completely organic, so any of the cloud titans, et cetera, are not counted in the international numbers. All of the international numbers is organic growth, so that's a nice number. In terms of contribution, in Q1 it was very high from the cloud titans. In Q2, we actually saw contribution from new customer wins, particularly pleased with some wins in Asia-Pac and in Europe, but especially Asia-Pac. And so we're -- while we would like to see even more execution internationally, we're pleased with the hiring and the progress we're making there, given we really only started our efforts recently in the last 6 to 12 months. We've established subsidiaries in all the major countries. We've started active hiring in all of these countries, and I think we'll see some encouraging wins, hopefully, resembling the same 4 verticals that you see here in the U.S., internationally. Ita, you want to take the second part?

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

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

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

So higher attach rates versus necessarily bigger projects?

Yes exactly, right.

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

Yes.

Your next question comes from the line of Kulbinder Garcha with Crédit Suisse.

I joined the call late, but my question is basically around revenue driver. Jayshree, this year, do you think all 4 verticals will be roughly equivalent again? Or will the cloud be much bigger than the others? And if you have any, how many above 10% customers did you have? Maybe you answered that one, but I just wanted to clear it up.

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

How do you expect the year to end?

Expect the year to end. Okay, got it. Well, we've had a very balanced first half, so -- and at the same time, I believe the -- one comment I really want to make on the cloud titans is it's not about one customer concentration. As you know, we are in 6 out of the 7 major cloud titans, and we're very pleased by the acceptance and expenditures of many cloud titans. So while we are deeply penetrated in -- one and especially Microsoft, we are pleased that the cloud titans, in general, are all growing. And as you know, they're large numbers, and if they grow, then that helps our numbers, too. But we're also seeing, as I said, this quarter, good wins in financials and high-tech enterprise. High-tech enterprise is comprised of many sub-verticals, if you will: the web services, software companies, high-tech companies that manufacture silicon. So it's a large catch-all bucket. So all 4 verticals, I expect through the year, will be well represented and diverse. They may be lumpy in the quarter, but so far, we haven't seen it this quarter or last quarter.

Your next question comes from the line of Simona Jankowski with Goldman Sachs .

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

Right. On the EOS subscription product, I would say we have received small acceptance still, and it is mostly in entry-level smaller customers. They're not your typical big, large data centers. More trials, I would say, than large-scale production deployment. I think customers are still getting used to the model. They're -- it's not one they're familiar with. Their old 20-year old habit of just buying everything together, so it's only the SMB customers who want to try and buy or feel their way or have smaller budgets that are going in that direction for EOS. Specific to Juniper, I am not seeing anything different. We have a great deal of respect for our competition. We see Juniper in the core. We haven't seen them much in the data center.

Your next question comes from the line of Mark Sue with RBC.

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

Right. Mark, I'm going to probably guess a little here, so I don't know if I have the perfect answer. But I would say our -- we have a four-pronged growth strategy towards our billion, first billion, let's say. And I would say they're fourfold. The first one is deepen in the 4 verticals. Most people think we're already there and we're achieving a lot from it, and while that's true, I would say we've barely scratched the surface of many. There's a lot of customers there. There's a lot of spend there, and there's a lot of awareness of Arista there. There's a lot of appreciation of our OS and our programmability there, so deepening in our verticals will give us the fastest and largest growth, I believe. The second is what you mentioned. I think the expansion to international -- we started frankly late, and we've been slow. We only really realistically started this year, so I think any expansion we do on the international to replicate what we've done in the U.S. will give us a growth potential in the next 3 to 5 years. And possibly, we also expect that our partnership with HP will give us expansion internationally, our technology partners, in general, including VMware. So the combination of our technology partners and international, I would agree with you, is a growth expansion strategy. The third one, I would say, is software subscription.

[Indiscernible] at a billion.

While I don't think our software subscription will be material to our revenue short term, it's a very strategic part of our growth strategy. And Ita and I and the senior management team here value it deeply, and so do our customers. There's a lot less people and assets available to absorb technology and make technology work for you and cut cost that are both CapEx and OpEx, and so this is a key indicator for OpEx control. And finally, last but not least, I've always committed to you that our foremost and primary commitment is the data center, but we do not preclude adjacencies. We believe the data center is the primary and core market, but many of the adjacent markets will come to us. And that'll be a natural longer-term part of our prospect.

Your next question comes from the line of Simon Leopold with Raymond James.

Great. Maybe my imagination is playing the best of me, but I kind of think I'm hearing a little bit of contradiction in some of the discussions about verticals. It sounds like you've talked about balanced verticals in terms of all 4, but you also sound more constructive, more positive on web scale. The titans, you emphasized several rather than the one big one. I want to try to understand if and what may be changing among the web titans, and one of the things I'd like to get a better understanding of -- we're hearing some suggestion of maybe a shift away from white box switches for all applications and maybe embracing solutions like yours for the higher-end applications, and I'm really looking at the web scale guys other than Microsoft that clearly has already embraced Arista.

Okay, Simon. So first of all, no contradiction intended. The first quarter and the second quarter have shown good balance on our 4 verticals. If I had to cite the verticals that contributed the most, it would be the cloud titans and the service and cloud providers, but I don't want to underestimate how well the financials and enterprises have done. Their TAM and their spending is lower, but the acceptance of Arista in these general-purpose clouds as they build general-purpose data centers and private clouds, I'm very pleased with. So I don't mean that to be a contradiction. I think they're actually quite consistent. In terms of...

And are you seeing them embracing your solutions rather than white box alternatives to a greater degree than they might have 6 months ago?

Okay, so let me address that. So first of all, the first part of your question was, "Did you have balance or did you not?" And absolutely, we had balance, and I explained the top 2 verticals. In terms of white box, first of all, we do not see the white box at all in all 4 verticals. I just want to be clear on that. We have seen the white -- we have 30 -- 3,390 customers. I have seen the white box phenomena in maybe single-digit customers out of the 3,390. Just to be really clear. When we do see it, and this is something we're very cognizant of, all good organizations that have engineering capability will always have the right to experiment and will continue to experiment on single-use cases and what kind of cost they can get and what is core and what is context to them. So as I've explained before, Simon, in the Facebook example, we work with their internal implementations to enable value on Wedge and on their Xbox through our EOS. So if a company has white box, that doesn't mean it's mutually exclusive, and Arista can't be there. So to answer your question even more explicitly on the last 6 months, we have not seen an uptick in white box interest. It's been about the same. It tends to be single-digit customers, and it tends to be largely experiments and lag. There are very few instances of captive, production-based white box implementation.

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

Jayshree, I guess in part you just answered the question, but let me ask you a broader question on competitive landscape. And the direct question being, have you seen any meaningful change? I know you just addressed the white box piece of it, but obviously, there's Cisco and others. So any change there? And then -- I mean, it's not a question, but it's a statement. And I apologize to put you on the spot, but I'm doing it by design. And I know Ita just arrived, so my apologies, Ita. But I would strongly encourage you -- I understand why you don't want to do it. But I would strongly encourage you all for the benefit of investors, sell-side analysts and yourself to provide the vertical breakout, and not just in the general terms that you have. And I appreciate that in terms of your comments about the balance, but I think it would help us, and it would help you to provide the actual exact disclosure. With that said, I'll go back to the question about the competitive landscape.

Thanks, Paul. Feedback taken, appreciate it. We'll definitely look into it. Regarding the competitive landscape, we have not seen significant change. We have had to compete in the last 6 quarters, I would say, more with paper tigers than with reality. In the last recent quarters, as the products come to market, it has actually strengthened the conviction of our customers even more that we have the best platform and product. And what I mean by that is not just speeds and speeds and buffering and latency and power and all of that good stuff that we derive from our chip, but really, the programmability of our software stack and the 10-year endeavor we put into that. No one is coming close. A lot of people use the words scripting, programmability, DevOps, NetOps. No one has come close to actually implementing the level of depth. And it's reflected, Paul, as you well know, in our R&D investment, which is top and most significant investment. So while it can look on paper like people have caught up, when people actually evaluate our product, we technically win 9 out of 10x, maybe 10x out of 10x, technically.

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

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

One final related question. In terms of the pricing environment, any meaningful change?

No, I was just looking at the ASP trends. So no, they haven't changed much in the last 2, 3 quarters.

Your next question comes from the line of Erik Suppiger with JMP.

So first off, for Marc on the legal proceedings. I think you're going to court twice in September. How quick do you expect the courts to come back with their decisions on the patents and the infringement? And then secondly, you're halfway through the year now. In the past, you've talked about Microsoft as a customer that would come down as a percentage of revenue but continue to grow in terms of dollars. I'm just checking, is that still your expectation for 2015? Would you expect the dollar sales to Microsoft to continue growing year-on-year?

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

You can take Microsoft.

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

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

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

Sure. With respect to the timing, so with the ITC, as you know, the first case is in the 944. That's going to happen through September. The administrative law judge decision for that, the initial determination occurs January 27, 2016. And then it goes to the commission, and the commission makes a decision on May 27. And then that goes to a presidential review of 60 days. That gets to July 27. The 945 case in November, that initial determination by the administrative law judge doesn't occur until April 26 of next year. Final determination by the commission is August 26, and then the presidential review of that isn't until October 26, 2016.

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

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

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

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

The Markman.

They're different.

Yes, so on the Markman case, that -- the Markman trial was for the 945, and only [indiscernible] to 2 investigations. We're still waiting on the Markman order. That would apply to the 6 patents that are in the 945 case. The decisions on those should occur, we expect, sometime within the next couple of weeks. And then those would apply to the 945 hearing that we're going to be having in November.

Your next question comes from the line of Vijay Bhagavath with Deutsche Bank.

Calling on behalf of Brian. Jayshree, a question on the Tomahawk, we get asked this question a lot by clients. Give us some understanding of the waterfall and the product cycle you see for Tomahawk. Do you think the product cycle starts kicking in from the fourth quarter and in that case, you would see an above seasonal Q1 of '16 with more 100 gig ports in the mix? And in general, on a full year basis next year, how would you view 100 gig approximately as a percentage of your mix? Because clearly, you have your customers, especially the cloud titans, doing 100 gig both in the leaf and in the spine.

Right, yes, good question, Vijay. I think both transitions will be slow and gradual, and it will be multi-quarters. It won't be just overnight in Q1 2016. In general, speed transitions take time, as you know, Vijay. I mean, we may realistically think they should happen, but the time from when they decided to happen to when a customer actually makes it happen is much longer. So I think Tomahawk and 100 gigabit in the spine will happen throughout 2016, and for that matter, 2017.

Perfect. A then a quick follow-on would be on data center routing with new Merchant Silicon like Jericho. Any thoughts on the product cycle ramp? Would that be second half of next year? Give us your view.

Yes. No, so we haven't really commented on our WAN and adjacency strategies, and we look to do that in the future when we're ready. But in general, I think what you're seeing here is that traditional networks, where you build switches in the campus and routers and the WAN and branches with routers, et cetera, all these what's often called places in the network are coming together. And I think you're seeing much more of an integrated, seamless pin structure, and so I think is going to apply to the WAN 2 as interfaces move more and more to Ethernet and routers move more and more to routing, and the noun becomes an adjective, if you will. These will not be market segments, and the existing companies may see their TAM shrink as these become features on products. So we see the spine as becoming a very relevant platform for the data center and cloud today, but we don't preclude the possibility of other features such as routing, especially, as you pointed out, the modern silicon coming.

Your next question comes from the line of George Notter with Jefferies.

I was curious about the 5 million port milestone. I think if I have this correct, you passed both the 4 million and 5 million port milestones this quarter. Is that correct?

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

Got it. Okay. And then I guess the real question behind this is, again, I think if I have it correct, it took you 3 quarters to pass, effectively, the 4 million port mark because then 3 quarters...

No, no no. It took me -- what I tried to say, maybe I got too cute with it. I'll try again. It took us 4 years, 48 months, to do our first 4 million ports. So from inception, basically end of 2008 to now. The first 4 million ports took us 48 months. The last million port took us 1/10 that time, less than 4.8 months.

Got it. Okay. I guess, my understanding is that for the September quarter, you were north of 3 million ports. You're also north of 3 million in the December quarter and also into the March quarter, so it took you those 3 quarters to ship an additional million ports and yet just in the June quarter, you shipped a million ports. And so I'm wondering if there's something that's going on here in terms of pricing because, yes, I'm not seeing -- I'm seeing certain -- lots and lots of growth certainly in the June quarter, but it seems like the port shipments relative to revenue were much bigger. So I'm just wondering if there's anything that's changed on pricing. That's just the question.

No. I think the one fact that's incorrect in your assumption is we didn't stay at 3 million ports for full quarter. We just didn't report when the 4 million happened.

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

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

Your next question comes from the line of Sanjiv Wadhwani with Stifel.

I just had another quick question on whether or not there was a 10% customer in the quarter?

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

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

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