Arista Networks, Inc.

Welcome to the third quarter 2020 Arista Network's Financial Results Earnings Conference Call. During the call, all participants will be in a listen-only mode. After the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time. If at any time during the conference you need to reach an operator, please press the star followed by zero. As a reminder, this conference is being recorded and will be available for replay from the investor relations section at the Arista website following this call. I will now turn the call over to Mr. Curtis McKee, Director of Corporate and Investor Development. Sir, you may begin.

Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me on today's call are Jay Shrealal, Arista Network's President and Chief Executive Officer, and Ida Brennan, Arista's Chief Financial Officer. This afternoon, Arista Network issued a press release announcing the results for its fiscal third quarter ending September 30th, 2020. If you would like a copy of the release, you can access it online at our website. During the course of this conference call, Arista Networks Management will make forward-looking statements, including those relating to our financial outlook for the fourth quarter of the 2020 fiscal year, longer-term financial outlooks for 2021 and beyond, our total addressable market and strategy for addressing these market opportunities, the potential impact of COVID-19 on our business, our product innovation, and the benefits of recent acquisitions, which are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically in our most recent Form 10-Q and Form 10-K, and which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. Also, please note that certain financial measures we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. We have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in our earnings press release. With that, I will turn the call over to Jay Shree.

Thank you, Curtis. Thank you, everyone, for joining us this afternoon for our third quarter 2020 earnings call. To start with, we all hope that you and your families are safe during the global pandemic. At Arista, we recognize our role and responsibility in supporting global communications and cloud infrastructure during these challenging times. We are working closely with our employees, supply chain, contract manufacturers, customers, and Arista Foundation to assist in business continuity initiatives and people's lives. Back to Q3 2020. We delivered $605.4 million for the quarter, with a non-GAAP earnings per share of $2.42. AK Services and software and support renewals contributed approximately 21% of revenue. Our non-GAAP growth margins were 64.6%, influenced by software and services mix, and a higher Asia-Pacific contribution. We registered a record number of new customer logos this quarter and million-dollar customers, a direct result of our momentum in the enterprise vertical and campus traction this quarter. In Q3 2020, Cloud Titans was our largest vertical. The enterprise is once again consistently our second-largest performer, followed by tier two cloud service providers and financial side for third place and service providers in fourth place. With respect to sector trends, cloud titans are now approximately 37%. Enterprise and financials also are approximately 37%. And providers, which is our cloud service providers combination, is approximately at 26%. What is clear is Arisia's cloud principles now apply to all sectors. And we are diversifying well across customers and verticals. In terms of geography mix, international contribution was 25%, with the Americas at 75%. The European business recovered from Q2, and the Asia business has had a particularly strong quarter. In the absence of a physical analyst day this year, we would like to shed some light on our strategy for addressing our $30-plus billion TAM. The past decade can be best characterized by ERISA's momentum in cloud networking. But in the past four quarters, we have experienced a triad storm of cloud-fighting volatility, COVID pandemic, and deferred revenue-related comps. Despite this tough reset year, we believe Arista will emerge stronger, not only returning to double-digit growth in 2021, but also aiming for consistent growth in the years beyond. We expect our multi-year growth cycle from three major product line contributors. One, our core cloud and data center products. Our largest business, building upon our flagship Arista EOS with the hallmarks of least fine topology across our five major verticals. Two, our second market is the network adjacencies with routing replacing routers and our recent entry into the cognitive campus workspaces. The routing market consists of core, spine, edge, and peering use cases for tier 1, 2, 3 service, cloud, and enterprises. The campus brings a cognitive unified edge for wired and Wi-Fi endpoints, as well as new IoT devices in a two-tier leaf, spine, or slide network. We do expect to disrupt the campus and router incumbency of the last few decades in the next few years. Our third category is network software and services based on software subscription models such as ERISA ACARE, Cloud Vision, Cloud EOS Rider for Multi-Cloud, Big Switch Monitoring, and our latest entry into advanced network detection and response with the acquisition of Awake Security. Elaborating on our focus on subscription-based software, this product line is typically multi-year contracts. Customers are driving mandates for network automation, monitoring, visibility across their data sets. We believe the recent acquisition of Awake Security is a strategic contributor that transforms the silo aspects of security into a seamless, secure network. The moment the cloud blurs the perimeter and the increased use of IoT and shadow IT means that our CIOs and CISOs need a network ground of truth. Simply storing the raw data or alerts isn't comprehensible data. A new AI-driven, data-driven, state-driven software stack like Arista provides is foundational. In our opinion, the security industry is going through a metamorphosis from point security to proactive, predictive, secure networking. Cloud Vision, combined with ERISA's 2020 acquisitions of big-switch networks for observability and awake security for autonomous threat hunting, are very natural software additions to this category. The cognitive campus is a priority for Arista's adjacent product line. We are witnessing a massive transition in the COVID era to work from home, where the boundary between the office, the home, the teleworker in transit, and the user is blurring into elastic and flexible workspaces. Arista's recent introduction of the cognitive campus is a state and data-driven model coupled with a unified dashboard for wired and wireless edge for next-generation, zero-touch campus deployments. This combined with the awake network detection and response security feeds into our campus visibility flow tracker for both IoT and OT applications. We do expect our campus portfolio to double by the end of 2021 as we invest in both engineering and go-to-market models. A fitting example is today's announcement of our flagship 750 series campus chassis, delivering a combination of industry-leading chassis, density, performance for high-definition video, failover resilience for rolling upgrades, cognitive PoE, and secure encryption. I would like to invite Andy Beckershine, our founder and chief development officer, to highlight our launch today. Andy?

Yes, we like markets that are ripe for real innovation, and the campus networking market is a prime example of that. With the launch of our 750 series modular chassis, we are introducing an extension platform that delivers more performance, more security, more visibility, and more power capabilities than any other product in its class. The 750 has 400 gigabits per second uplink throughput, which is five times the performance of our nearest competitor. This level of performance is key to support Wi-Fi 6, where each access point has up to five gigabits throughput. With a single 750 chassis, we can support a full complement of 384 Wi-Fi 6 access points. In addition, the 750 offers max-sec encryption on every port, which supports secure communication from the Wi-Fi through the entire campus network. The 750 also breaks new ground in density, being 3U more compact than our closest competitor. Combined with the legendary reliability of Arista's EOS offering system, the 750 offers unmatched performance security, availability, visibility, and power handling.

Thanks, Andy. That was great. I'm excited. I could use one at home. Next-generation routing is another key adjacent market for us, whereby we're bringing the union of two box-level approaches, Layer 2 switches and Layer 3 routers, together for rich protocol support, resiliency, scale, and programmability. This has been a four- to five-year endeavor for us to bring disruptive economics via advanced merchant silicon and Arista's modern software stack, EOS. We're trying to see the fruits of this labor. Arista customers now see us as a compelling cloud and carrier-grade routing alternative to expensive legacy routers. We're extending beyond classical leaf-spine intra-DC use cases to multi-terabit routing, offering lower power and higher density interconnect, accelerating WAN and inter-DC routing use cases. Our investments in the simplification of Arista's routing stack with standards-based EVPN, BGP, and segment routing are yielding early traction. We have won a few important Tier 2, Tier 3 service provider customers for many of these use cases, including fine interconnect, multi-access edge, Layer 2, Layer 3 VPNs, and tiering use cases. Our core universal cloud network design for data center continues to expand with Arista as the pioneer. We have been the market leader, driving to the number one position in 100 gigabit Ethernet switching market and early leadership in 400 gigs with flexible software partnerships for Sonic, OpenConfig, and FBOS with our CloudTitan customers. We have been pushing beyond the local storage compute and AI clusters at cloud scale. This quarter, we delivered cloud vision managed in a time-series state-driven database as a network-wide service hosted in the cloud. Clearly, we're enabling cloud principles across the entire enterprise with five A's of agility, availability, automation, analytics, and an AI and API-driven network. Anshul Sudhana, our chief operating officer, will add some more color on our cloud customer traction. Anshul?

Thank you, Jayashree. Barista has been a leader in cloud networking based on our liberal execution, product quality, and ability to co-develop with our customers. Cloud companies are highly impressed with the work we've done over the last decade and are engaging us more than ever to discuss their architectures for the future. The advent of 50GX30s and related silicon is driving a product transition. We are winning new RFPs for next-gen products, both 100G and 400G. We have expanded our footprint from data center lead spine and DCI to now Encompass, WAN, and Edge use cases, traditionally supported by legacy routers. While there is a lot of talk about white boxes and 400G, Our customers have maintained status quo. We are not seeing a change in position from this status quo. Customers who use white boxes are continuing to use white boxes, whereas customers who use oyster switches are continuing to use our products today and for their future designs. If anything, some use cases currently covered by internally developed white boxes may transition to our feature-rich products in a few years. Cloud companies operate at a massive scale and they are continuing to grow. This scale makes them lean more on us for technology and support. Our cloud customers see immense value in working with us and we have high customer satisfaction here. Our portfolio is highly competitive and we are being told that we are ahead of competition. Hence, it is unlikely that we will see significant share shifts Savvy cloud titans are not influenced by pretty marketing slides. Our R3 series products have now been qualified by all our major cloud customers for several 100-gig and 400-gig use cases. We will keep marching on. Back to you, Jeshvi.

Thanks, Ranchu, and we will be marching on. Well said on the cloud titan success. So in summary, Arrestive Vision now transcends LAN, WAN, cloud networking, with clear diversification across customers, products, and verticals. It's rooted in a more software, data-driven network, built across customer data sets, and managed by cloud vision. We have built a transformative architecture, harnessing the new trends in IoT computing, unified edge, archiving data across the network. Our customers resonate with this vision, and I couldn't be more upbeat on our strategy, our innovation, our quality, our support, and our customer migration from legacy silo places in the network to cognitive clients to cloud networking, which we call places in the cloud. We have now deployed a cumulative of 40 million ports over the past 12 years. With that, I will turn it over to Ida, our Chief Financial Officer, for more financial specifics. Ida?

Thanks, Treasury, and good afternoon. This analysis of our Q3 results and our guidance for Q4 2020 is based on non-GAAP and excludes all non-cash stock-based compensation impacts, certain acquisition-related charges, and other non-recurring items. Full reconciliation of our selected GAAPs and non-GAAP results is provided in our earnings release. Total revenues in Q3 were $605.4 million, down 7.5% year over year, well above the upper end of our guidance of $570 to $590 million, and up 12% from the prior quarter. While we saw some improvements on the supply chain front, shipments remained somewhat constrained, with some expected continuation of extended lead times into Q4. Service and software support revenues represented approximately 21% of total revenue, down slightly from 22% last quarter. International revenues for the quarter came in at $152.7 million, or 25.2% of total revenue, up from 19.4% in the second quarter. While the shifts in geographical mix on a quarter-over-quarter and year-over-year basis was largely due to the location of deployments by our Cloud Titan customers, we did see some incremental improvements in our in-region businesses also. Overall gross margin in Q3 was 64.6% above the midpoint of our guidance of approximately 63 to 65% and consistent with last quarter. We continue to recognize incremental COVID related costs in the period, including elevated freight and component costs. Operating expenses for the quarter were $159.4 million or 26.3% of revenue. up from last quarter at $144.1 million. We began to increase operating expense investments during the third quarter as our top line performance for the year continued to improve. R&D spending came in at $106.1 million, at 17.5% of revenue, up from $91.6 million last quarter. This reflected increased employee costs and increased new product introduction related spending in the period. Sales and marketing expenses, $43.1 million, or 7.1% of revenues, up from $41.9 million last quarter, with increased variable compensation and other personnel costs. As a reminder, we continue to benefit from lower COVID-related travel and marketing expenses. Our G&A costs came in at $10.2 million, or 1.7% of revenues, down slightly from last quarter at approximately $10.6 million. operating income for the quarter was 231.5 million or 38.2 percent of revenue other income and expense for the quarter was a favorable 13.2 million and our effective tax rate was approximately 21.6 percent this resulted in net income for the quarter of 192 million or 31.7 percent of revenue our diluted share number was 79.3 million shares resulting in diluted earnings per share for the quarter of $2.42, down 10% from the prior year. Please note that included in other income and expense for the quarter was a one-time gain on the sale of investments of $9.4 million. In addition, given current low interest rate environment, all other things being equal, we would expect other income of approximately $3 million per quarter throughout the coming year. The acquisition of Awake Securities closed on October 7th, and we are now focused on integration and purchase accounting. The acquisition will not have a material impact on the financials for the quarter. Now turn to the balance sheet. Cash cash equivalents and investments ended the quarter at approximately $2.85 billion. We repurchased $167.3 million of our common stock during the third quarter at an average price of $208 per share. As a reminder, we have now repurchased $661 million of 3.2 million shares against our board authorization to repurchase $1 billion worth of shares over three years commencing in Q2 2019. In terms of capital allocation, it is expected to continue to execute opportunistically against the remaining authorization. We generated $215.1 million of cash from operations in the third quarter, affecting solid net income performance and a consistent level of overall working capital investment. We expect to continue to strategically increase inventory levels through the end of the year as we improve lead times and attempt to buffer against any future COVID-related supply chain disruptions. DSOs came in at 46 days, down from 65 days in Q2, reflecting linearity of billings in the period. Inventory turns were two times, down from 2.3 last quarter. Inventory increased to $438 million in the quarter, up from $327 million in the prior period. as we continue to buffer certain components and products. Our total deferred revenue balance was $562 million, down from $577 million in Q2. As a reminder, our deferred revenue balance is now almost exclusively services related. The level of service deferred revenue is directly linked to the timing and term of service renewal, which can vary on a quarter-by-quarter basis. Accounts payable days were 70 days, up from 59 days in Q2, reflecting the timing of inventory receipts and payments. Capital expenditures for the quarter were 2.5 million. Now turning to our outlook for the fourth quarter and beyond. While we remain cautious around the impact of COVID-19 on the economy and our business, we have seen some incremental improvement in underlying business strength. Activity in our enterprise and provider sectors has remained healthy, with increased win rates across what is for us a relatively under-penetrated part of the market. In addition, we've continued to solidly and consistently execute against the needs of our Clyde Titan customers. We believe a combination of these trends, combined with favorable year-over-year comparisons, support the current consensus growth rate of 13% to 14% for fiscal 2021. On the gross margin front, we will continue to reiterate our overall gross margin outlook of 63% to 55%, with customer mix remaining the key driver. Turning to spending and investments, While we will continue to carefully manage spending, we are committed to making go-forward, results-based investments in business. This includes continued go-to-market expansion to support enterprise and campus growth, and investments in R&D to support innovation across the business. While it won't happen overnight, especially in an environment of resumed top-line growth, we would take this opportunity to remind you of our long-term operating margin target of plus or minus 35%. Finally, our outlook discussion above and our guidance for Q4 reflects our current understanding of COVID-19 and its impact to our business and supply chain. This is, however, inherently uncertain, and we will need to continue to monitor and attempt to mitigate new challenges as the situation unfolds. With all of this as a backdrop, our guidance for the fourth quarter, which is based on non-GAAP results and excludes any non-GAAP stock-based compensation impacts and other non-recurring items, is as follows. revenues of approximately $615 to $635 million, gross margin of approximately 63 to 65%, operating margin of approximately 37%. Our effective tax rate is expected to be approximately 21.9%, diluted shares of approximately 79 million shares. I'll now turn the call back to Curtis. Curtis?

Thank you, Ida. We are now going to move to the Q&A portion of the ERISA earnings call. Due to time constraints, I'd like to request that everyone please limit themselves to a single question. Thank you for your understanding. Operator, you may go ahead.

Thank you. We will now begin the Q&A portion of the Arista earnings call. In order to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. We ask that you pick up your handset before asking questions in order to ensure optimal sound quality. Your first question comes from the line of Samik Chatterjee from J.P. Morgan. Your line is open.

Hi. Thanks for taking my question. I'll just keep it simple. Jayashree, I think everyone on the call would recognize that you sound a lot more confident about returning to double-digit growth than you did 90 days ago, so I'm wondering what's driving that. Is it some of the 400 gig wins coming in as you expected, or is it the underlying customer spending starting to improve that's driving that increased confidence? It would be heard a quarter ago. Thank you.

Yeah, no, thank you, Samig. I think when you look at the foundation and fundamentals of Arista, they didn't change, right? We've always had superior products and very strong customer traction. But I think we got our customers and Arista got used to the uncertainty of COVID, and COVID became a new norm, and people have to start planning their spend. So we saw a very balanced and customer traction across all our verticals and all our sectors in Q3, whereas I wouldn't say the same for Q2 and Q1, where we were still figuring things out. So I think the combination of an unchanged strategy, a highly differentiated product, and we're just winning in every sector, and there's no silver bullet, but coming on all four cylinders gives us a newfound confidence. Thank you, Sammy.

Thank you. Your next question comes from the line of David Voigt from UBS. Your line is open.

Great. Thanks, guys, and good quarter, great guidance. Maybe just a big picture industry question, if you guys could entertain me. Can you share your thoughts on the proposed Marvell inside transaction that was announced last week and maybe what it might mean for the industry holistically as you kind of move forward into 2021, if that would be great?

I try. I mean, I came from the semiconductor world two decades ago, but as you know, there's been a lot of semiconsolidation, NVIDIA ARM, Maxim, Analog Digital, and now Marvell Insight. I think the way to look at this is semiconductor companies are all, the large ones are trying to get larger, and the smaller ones are producing some real innovative technology but need scale. We are very impressed with Insight. They've been an important partner for us, and they have both very best-of-breed technology in the 30s and the optic side. And it's something that Marvell lacks, so hopefully some of the strength they bring, especially to the cloud, will help Marvell.

Thank you.

Thank you, David.

Your next question comes from the line of Sammy Baudry from Credit Suisse. Your line is open.

Thank you very much. I just wanted to just check on a comment made by Anshul earlier in a transcript regarding white boxes. And he made the comment that some customers may deploy white boxes today and then eventually swap that out for a future-rich RISC product in the future. Now, there may be a rationale behind why they would want to deploy, you know, data centers filled with white box infrastructure or white box equipment and then eventually swap it out. Can you just explain to us the transition that would take place in design or just in the thought process for why they would do that after they've gone down the white box route?

Sure. I mean, the word I've talked about is just from one dimension for many, many years. Remember, our customers do that analysis in both directions, not just one. And as their scale grows and their needs grow, the network is getting more complicated and in certain situations when they reach a point where they need even more functionality than is easy to build internally and they want to stay competitive in the market and not miss on timing, they do start looking out as well. But as I mentioned, these are future trends that take a couple of years at least to happen. But these are certainly brewing discussions and issues going on in our space today.

Great. Thank you. Your next question comes from the line of Alex Kurtz from KeyBank Capital Markets. Your line is open.

Thanks, Sundar. Glad to hear everyone's doing well and safe at Arista and congrats on the quarter, Jayshree. To find your comments about software and maintenance becoming roughly 20% of the business, can this growth in your portfolio of software products, whether designed internally or acquired, to maybe accelerate that software renewal base to where maybe in a couple of years we're looking at 30%, 40% of the business if you can go back to these big cloud titans and kind of demonstrate the value of these bigger software portfolios that you didn't have a couple of years ago and really expand that base of software.

Thanks, Alex. Good question. I think it's very observant of you to note that when we say it's 20% of our business, it's not just services. It's software renewals and subscriptions. So it's already starting to have a contribution. Can it be greater, greater than 20, 25? Yes. It would be harder to be 30 and 40, especially with the Cloud Titans, because Cloud Titans tend to think they can and they have the resources to build many of these tools themselves. So I would say all the other four verticals are more likely to embrace a software subscription, while the Cloud Titans may take it in bits and pieces. They would take it in components, but not in entirety. But I certainly think this segment where we can have subscription multi-year contracts is an important part of our triad tool of core networking, adjacent networking, and network as a service capability.

Thank you.

Thank you, Alex.

Your next question comes from the line of Taliani from Bank of America. Your line is open.

Hello. Hi, Jayshree. Hi, Tal. I have a question on the trends in the quarter for Product growth, so overall revenues are down 7.5%, but it's not even between products and services. Product growth is down about 13.5% year-over-year, and services are up 26%. So I'm trying to understand both sides. I'm trying to understand the strong growth in services versus the steeper decline in products.

Yes. So first, remember, again, services includes many of our software subscriptions and multi-year contracts. So it's not just services. Right. But a product is very clearly perpetual product, right? So, look, I think the comps with deferred revenue never helped us from last year to this year. But I wouldn't read too much into the trend except to say we're getting stickier with services and software, and we can only do better with product.

Yeah, I mean, I think, Carol, the services should continue to grow and continue to be a more meaningful piece of the business, and they're the software on top of that. And then, you know, product is recovering, but it is recovering. You can see that in the Q4 guide and, you know, in our commentary for next year as well. So I think, you know, there's just different drivers at this particular point in time, but they should both start to grow as we go forward.

Got it. Thanks. Thanks, Charles.

Your next question comes from the line of Fahad Nijam from MKM Partners. Your line is open.

Thank you for taking my question. A couple of things. If I look at your working capital, it seems like the inventories have gone up significantly while your accounts table are also off of it. Can you just help us understand what's happening? Why the inventories are up so much? Are you expecting a significant forthcoming demand ramp in the next couple of quarters?

Yeah, no, I think, Farhad, what we're really doing is we're buffering, you know, again, some of the uncertainties around COVID. And if you look at the queue when we file it, you'll see that a good portion of that increase is still raw materials and components. There was some uptick in the finished goods right at the end of the quarter for particular products, but we still have more work to do around that. you know, expanding that to other products. But our goal is to, you know, to have sufficient buffers that if we do get some more shocks from COVID that we're able to react and that we're in a better position to react than we were maybe on the first wave. So it really is just a focus around making sure we've got more optionality and flexibility.

I appreciate that. Thank you. Thanks, Rahad.

Your next question comes from the line of Paul Silversheen from Cower & Company. Your line is open.

Thanks. I think you kind of said it during the call, but I'm going to ask you if you could be in your outlook for next year, that's all digital growth and your endorsement of a 13 to 14% consensus number. To get there, I think I heard you say you expect your campus portfolio to double by the end of 2021. Are you saying you expect campus revenue to double? And can I ask you to go through what your expectations are for the cloud? for Enterprising Financials and for your service providers to get to that public district credit?

Hi, Paul. Thank you. Yes. So, as you know, we said last quarter that we have achieved – this is our first year at campus. We're still young kids here. And we've achieved our first $100 million. And if you may recall, we said it would take us four to six quarters to double. I don't yet know if it will be four or six, but we are feeling pretty good, particularly with our product announcement today and the campus traction we're getting. uh that we didn't feel last quarter so yeah the goal is to definitely double that 100 million to 200 billion by the end of 2021 in revenue and let's hope we can do better uh in terms of segments i think it's too early to call a breakdown um but we're very comfortable with the annual consensus uh for 2021 you have you want to answer that

Yeah, no, I think we're not going to try to do it by vertical at this point, right? We feel like there's between the campus stuff that you talked about, between the growth in services, you know, cloud has resumed growth, and then the rest of the business has also been performing well. I think between all of those drivers, you have, you know, you have multiple different ways to get there, and we'll see exactly how it plays out. And I think we're not going to try to pick which verticals. We're going to do lots at this point.

Can I add to this? I trust that to get there, cloud has to be healthy by definition.

No, I think, I hope you noticed our upbeat tone, especially on shows. You know, we started the year saying it will be flat to down, and then we said it will be flattish, and at this point I think we're feeling like clouds can be a growth, cloud titans can also grow next year.

I appreciate it.

Thank you. Thanks, Paul. Thank you, Paul.

Thanks, Paul. Your next question comes from the line of Jeff Qual from Wolf Research. Your line is open. Yes, thanks very much.

I was wondering if you two wouldn't mind giving us a little bit of some of the thought process behind the guidance. I guess one part is you, you know, there's another partner in the supply chain and one of your customers that passed it all over 2020. I'm wondering if that particular issue in Sammy would resolve. And then the other question is could you help us

little bit with the assumption of 400 and when that starts to layer in to the 2020 out 2121 outlook thanks you yeah no I think for the again the rationale for the for the guidance I think if you look at the very pieces pretty much what we talked about with Paul a few minutes ago right I mean there are multiple different pieces of the business and we've seen you know, positive trends across those sectors, right? Not all of those, you know, reflected in revenue today, but, you know, in the enterprise world being, you know, good, solid wins that will drive some revenue traction into 2021. And then for cloud, I think we feel like we've got, you know, we're in the window of starting to understand their plans for next year and feeling more confident around those. drivers as well. And then obviously the rest of the business continues to glow looking at service software, et cetera, the more ratable piece of the business. So I think those are the building blocks and we like to put those building blocks together in multiple different ways and feel good about the guidance and that's kind of where we came out for next year.

Yeah, Jess, I think Angela said this best. We expect cloud-citing trends to improve in 2021. based on both the CapEx projections, which for us isn't a huge indicator because we're a small number, but bulk of these deployments will be 25 gig, 100 gig, and even some 400 gig. I think the white box on the overall competitive landscape, much as everyone fears it, is unchanged, and we're seeing a status quo and look forward to share gains and new roles in campus, data center, routing, and cloud.

Okay, great. We'll follow up. Thank you both very much.

Thanks, Jeff.

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

Hi, guys. Thanks very much.

I'm very interested to hear the commentary about routing and all the different use cases you're pursuing in that space. Maybe you could kind of talk about your definition of success in routing, and also could you give us a sense for where you are now in routing applications, percentage of sales or amount of revenue you're driving there, and then maybe looking forward, what use cases are you in today and what use cases will you be in going forward? Thanks.

Yeah, sure, George. It's difficult to break it down, as I've always told you, because routing and switching often go together. But what we saw as a trend is, you know, we've always sort of aimed for the big elephants or the Tier 1 service providers, and those take time. But we started winning, particularly this year. We turned the corner on winning a lot of Tier 2 and Tier 3 providers, not only in the U.S., but internationally. And these use cases tended to be telco cloud. Some of them were just very happy with the multi-vendor combination of, you know, VXLAN, EVPN, BGP staff from us. Some of them were peering use cases. So these are all classical router use cases with better disruptive economics, programmability, resilience, and routing. features that they've come to know and love from others, but that they could get better from us. And then also we're doing very, very well in the cloud customer base as well. We have been for some time. So the culmination of all this is to say that routing is not just with the service providers. It is now permeating all our five verticals.

Got it. And is there one product delivery or feature delivery that has allowed you to turn a quarter in service provider space or anything you can attribute that to?

If you know the service providers as well as you do, it's never one feature. It's a long list of them. So we've been working it for four to five years, and I think the culmination of it has led to more success. But there's always one more feature to do, George, as you know.

Well, thank you, George. Thank you. Your next question comes from the line of Rod Hall from Goldman Sachs. Your line is open.

Yeah, thanks for the question. I wanted to just ask kind of a housekeeping question and then the main one. The housekeeping is do you guys think deferred revenue will become an issue in 21 because of 400-day rollout? Do you think we'll see product deferred revenue building up again? And then I also wanted to go back to enterprise. It seems like a time when enterprises, if anything, would be slow spending, but you guys have really accelerated at least sequential growth there, and there's a lot of absolute additional revenue in Q3. So just curious, do you think you're pulling any revenue forward on enterprise, or, you know, how does that look like it continues the next few quarters for you? Thanks.

Peter, you want to answer that? Yeah, I think on the deferred, it's always difficult to forecast when we'll have customer requirements, et cetera, for acceptance. I mean, it tends to be, it'll have to be for some very differentiated or different product set, particularly under the current accounting. So we'll see. It's hard to predict if there will be some of that or not at this point. But it's definitely, it's more difficult to get to a deferred bar. It would have to be a very differentiated product going forward.

Well, Rod, I'll just say it feels good to be back after a tough few quarters. The enterprises love our product and they want to buy more. And if anything, I would say opposite of Poland, we're still slightly supply constrained versus demand and are experiencing some shortages that will hopefully improve by the end of the year. So no Poland for sure.

Okay. Thanks, Rod.

Thanks, Rod.

Your next question comes from the line of Jim Suba from Citigroup. Your line is open. Thank you very much and really heartfelt congratulations to you and your team for our very strong results and outlook during COVID. My question is regarding the outlook for 2021. when you mentioned consensus up 13% to 14% and you're comfortable with that, does that bake into the most recent CapEx outlooks that we were provided last week?

It's notable that, like, Facebook gave an outlook of, you know, materially up the percent.

And I know that you were wrapping up and getting ready for earnings and things, but I believe their CapEx is supposed to be up 30% to 40%. But would that be additive? Thank you.

Yeah, Jim, no, I mean, this is our current view as of today of what we think we feel comfortable with for 2021, and then, you know, we'll see. There's always going to be puts and takes, and the CapEx to networking correlation has its challenges, right? So we'll see where it goes from there. That's what we see as of today.

Jim, thank you for the wishes. As you know, the CapEx includes building, leases, capital. So the networking component is very, very small. You and I were talking earlier, as I was with Aishal too, it's generally less than or around 5%. So it's hard to make any specific decisions based on CapEx. But as an overall trend, we are pleased that the CapEx is going up next year. But then we'll keep watching this quarter by quarter because it tends to be lumpy and volatile.

And congratulations again to you and your team.

Thank you, Jonathan.

Thanks, Jim. Your next question comes from the line of James Fish from Piper Sandler. Your line is open.

Hey, congrats on the quarter, ladies. Ida, you know, you went over the negatives of the higher freight costs, but also the positives of lower travel. To your best understanding, what was the net impact of COVID-19 on APEX this last quarter? And then DSOs would imply a more front-end loaded quarter that that either insinuates a slowdown in September or whether it's a lack of needing to push more business that we have a strong backlog heading into Q4?

Yeah, no, I mean, the DSO is actually the biggest driver this quarter was just the exeter with the high balance at the end of last quarter. We were very back in mode at last quarter, and then you can collect, you know, against that, and that drives some good traction through the quarter. So I think we were, you know, Jayshree mentioned we still have some supply constraints.

We were.

you know, still receiving in inventory, and you saw that in the accounts payable as well, right? So we were still a little bit back-end loaded through the quarter, but we had a good balance to collect against coming into the quarter. You know, I don't know that I'm going to try to size exactly what the COVID impact is. There is a little bit in gross margin, and you've seen that in the product margins. And, you know, there's travel from marketing expenses, a couple million or so that comes out of the sales and marketing line. because of it as well.

Understood. Thanks, and congrats, Jen. Thank you.

Thank you, James.

Thanks, too.

Your next question comes from the line of Jason Ader from William Blair. Your line is open. Thank you. On the campus side, I'm wondering what types of customers are actually buying this stuff in the midst of working from home? It's just... So that's kind of the first part of the question. The second part of the question is the 750 series product, is this a big hole in your portfolio and do you think that it could actually accelerate some of your traction in the campus market?

First of all, you'd be pleasantly surprised, as I am, that even though people are not coming back to smart buildings or their headquarters, it's really vertical dependent, as you know. Some of the logistics and healthcare and some of the business-critical ones do need to go back and do need connectivity and performance in a far more distributed, elastic fashion. So I think campus is back, just not the way we thought it would be. The emphasis on unified wire, wireless, you know, rather than specific smart buildings is the change we're seeing. And it also gives them, what we noticed is it's also giving them a chance to plan better. Because if everybody's in the building, you can't plan. But now you can do a lot more proof-of-concept testing. I'm very excited with the 750. There's a whole billions of install base of some of my old products. called a catalyst that, you know, are ripe and old in age. And, Anshul, you want to comment on the beauty of that?

Absolutely. Jason, we're very excited with what you're doing, but note a lot of this is driven by feedback from customers. There's immense interest in the 750 series and us broadening our portfolio. When you look at the Fortune 1000 type of enterprises, they actually need high density and high performance even in campus. And yes, there are certain companies thinking that since the employees are not in the office, let's not upgrade or refresh. But there are also certain companies thinking that there aren't enough employees in the office, so let's go ahead and refresh. And that's really what's driving a lot of the change in the enterprise as well. but the features that consistency or cloud vision automation a lot of visibility and the benefits to give to people is important to them if your reader conference has jiggered you don't want to be debugging in the middle of the day you need to resolve by itself and move on and those are the capabilities we deliver with our product great thank you jason this is the catalyst uh comparable from cisco

I think there's a couple of them.

There's the 4000 series and the 6500 series.

And they cost $9,400.

And the presently shipping one is the $9,400. But the older ones are the 4K and the 6500. Thank you.

Your next question comes from the line of Ryan Coots from Rosenblatt Securities. Your line is open.

Hi, thanks for the question. I wonder if we could circle back to the campus opportunity again and look at the competitive front there. Obviously, you guys have great technology. And how do you feel you're progressing in terms of building out your channels and displacing the big incumbent there in terms of having influence over these larger enterprise, global 2,000 type customers? Thanks.

Thanks, Ryan. I think we have to understand that we are in our second year of campus, and if you look at our competitors, they're in their 10th or 15th or 20th year. They're very mature. So definitely we've got work to do on go-to-market models. So our first area of focus there is our existing customers. We have over 6,500 of them. Some percentage of them love our EOS and Cloud Vision and want to use us. The second is we are making more progress on the channels. Aside, we're not signing up everybody, but we certainly see a strong international focus on channels, and I think that will be something we will continue to invest in. And the third is, for the last two, three years, we have been investing in the enterprise go-to-market led by Chris Schmidt and Ashwin Kohli under Ashwin. So we're starting to see the fruits of our labor in just enterprise traction, whether it's in the data center or campus, and it's taken us the better part of two to three years to achieve that.

That's great, Jayshree. Thanks very much and congrats on the quarter.

Thank you, Ryan.

Your next question comes from the line of Yitai Kidron from Oppenheimer. Your line is open. Thanks, ladies and gentlemen. A couple for me, maybe just kind of to drill down some of the questions we're asked. First, on the cloud, clearly you're more bullish here, so it's great to hear. Can you clarify whether this includes Facebook server refresh? Is that finally back on track and you've got a piece of that? And then? Picking back on the question that Jason had on the campus in U750, congrats on that. Cisco just refreshed in 9400. I guess when I look at your solution right now online, it looks like you have a couple of cool features there, always on PoE, data supervisor, data plane separation. But it was my impression that this whole chassis campus category is on a massive decline. Customers moving into fixed architecture is not modular at all. So help me understand how much really is the opportunity here, and when you talk about your confidence in doubling the campus business for next year, is this going to be a material contributor to that, or this is really for thereafter?

Oh, boy. How many questions was those?

Three within one.

Lovely. We'll keep our answers shorter than your questions about that. Do you want to take the cloud one?

Absolutely. I wouldn't say that the Facebook server refreshes in our guidance model, but all of our flight items network plans for the next year are in our model. The decouples are a little bit, and we have the data we have today from our customers using that. So we're confident that there is growth coming back next year on that site.

Right. And on the 750, you know, both Anshul and I have been involved a lot in chassis in our prior lives. I think if there's anything that will be under constraint, it's the stackables. Customers are moving to more and more distributed 1RU, and one of the things that probably got a little unnoticed in our announcement today is our 2RU 96 port, which obviates the need for any stackable. And then for the really high-density distributed buildings, which have large employees, large headquarters, You do need a 750. You need the investment protection of 100 gig uplinks. You need the density and, you know, footprint and power. You need the operational power management. You need the security. You need the always-on failover time for rolling upgrades. And I think what's happened, at least in our minds, is the chassis has gone from being a physical cable client discussion – to much more of an automation visibility security discussion you need all the properties that you had in the data center so that market is coming to us so um we feel good that there's a you know it's a new product it will take time to qualify but it is a contributor to our number in 2021. very good thank you

Your next question comes from the line of Nita Marshall from Morgan Stanley. Your line is open.

Great. Thanks. Maybe you wanted to touch on just kind of what sort of traction you're seeing with existing customers from your big switch and awake security acquisitions and just whether that could be, understand it's not material to Q4, but a more material contributor to 2021. Thanks.

Thanks. Yeah, thanks, Mika. I definitely think it's a strategic contributor to 2021 in bookings. As you know, the revenue may follow as multi-year contracts in software, network software, and subscription models. So how material will it be in 2021? Probably small. But both those are very strategic to influencing our customers' decisions on the data center and campus. And in general, helping with their operational, their architectural experience and their operational experience. It's a huge differentiator. So observability, monitoring, in-line data analysis capability, and then the autonomous threat hunting, you know, it's so important now because the firewall or the perimeter for the firewall has just collapsed. So the ability to do that is, you know, we just closed the awake acquisition in October. It's too early to tell. But the one thing we can tell is everyone's interested in it. Ashu, you want to add to that?

With IoT and sensors in campuses and work environments, the monitoring is going to be very, very different, and there's an unmet need in this space today, and I think it will do very well with the AI technology over there, as well as big switch in the monitoring side.

Great. Thanks. Thanks, Nika.

Your next question comes from the line of Aaron Rakers from Wells Fargo. Your line is open.

Yeah, thank you for taking the question. I want to go back to one of Esai's questions. And I can appreciate that you're not factoring in kind of, you know, Facebook and server refresh cycle, you know, in the context of your guidance. But if you go back in time, you know, how do you think about the context of server cycles and how that pulls through your business just to give a historical backdrop? Because if you look into 21, you've got, you know, obviously a big refresh for Intel. You've got AMD pushing into server CPU cycle. I'm just curious to how you think about that. that pull through effect on a risk assessment. Thank you.

Hi, Aaron. I don't think it's changed much. First, what happens is you've got to get the buildings and the power and the cooling in. Then you've got to get the servers. And there's typically a one to two quarter lag on the network. And so clearly the server cycle comes ahead of us, which is why we felt the pain we did last year. Hopefully we'll feel the gain of it next year.

Thank you.

Thank you, Aaron.

Your next question comes from the line of Pierre Figaro from New Street Research. Your line is open.

Hi, thanks for taking my question. Just when you mentioned in your opening remarks that outside of your core switching markets, you had gross opportunities in routing, campus, and software and services, and I was wondering, you know, over like a three, maybe to five-year time horizon, How much of your growth do you think is going to come from these additional segments versus how much is still going to come from switching your core switching market?

Well, Edith's telling me not to answer this question. From a vision perspective, we think those two segments, the new markets where we're under-penetrated, we're in the early innings, in both network adjacencies and software and services will grow faster than our core market. How about it even at that? Is that a good enough answer? That's a good enough answer. All right.

Thank you.

Thank you, Pia. Bye.

Our next question comes from the line of Tim Long from Barclays. Your line is open.

Thank you. Can we just hit on the telco vertical? It seems like it's still towards the bottom of the pecking order, at least in your results. So what's going on there? What do you think could get that going? Is it just increasing the routing use cases and further penetrating on that regard, or maybe the addition of more security features, which often do well in the telco networks? Thank you.

Thank you, Tim. Look, I think unlike the cloud where they will adopt our routing features even if we're missing one or two and they'll operationalize it, you know very well service providers want every bell and whistle. And as I said in my opening remarks, it's taken us a better part of four or five years. We're making very good traction in tiers two and three. Tier one is still taking time, but in this year we have won some early design wins in tier one as well, but the numbers are small. So I think in order to make them big, they need to send more from us.

Great. Thanks, Pam.

Your next question comes from the line of Anit Daryanani from Evercore. Your line is open. Thank you.

Perfect. Thanks for taking my question. If I just go back to this double-digit sales flow of expectation for calendar 21, is that an organic statement? Is that a total revenue growth statement? How do we think about that? And then broadly, when I hear you talk about calendar 21, it sounds like the growth vectors are getting much more diversified than they historically have been. And I'm wondering how does that play out into the operating expenses and perhaps the need to expand your infrastructure further in calendar 21?

So just, Amit, just to take the question up front, it is absolutely based on products as we have now organically. We're not factoring in any future products or M&A in that discussion. And maybe, Ida, you want to talk about the investment model?

Yeah, I think on the investment side, you know, with the top line returning to growth, that gives us a lot of room to make those investments. and maybe a little bit more than that, we'll see. But we certainly have the growth on the top line to do that. My script did remind everybody that our target model is 35% operating margin, and so we're reserving the right to do that should we find the right investment to make. We'll be very metric-driven around that as we go forward, but that's kind of the target model longer term. In the meantime, we'll have the benefit of top-line growth to help with the investments in the near term.

Thanks a lot.

Your next question comes from the line of Simon Leopold from Raymond James. Your line is open. Thanks for taking the question.

I wanted to get your sense on a scenario. If we assume an existing Arista customer wants to upgrade a data center to 200 GIN, not 400, but 200 GIN,

What does that mean for a risk? Is this a line car change or a swap of chassis? And if it is a swap of chassis, do you risk losing share in that kind of upgrade scenario for one of your customers?

Thank you. Sure. Simon, while we haven't talked about 200 gig broadly, there are certain customers looking at these types of technologies and essentially staying with the four-lane architecture at 4x50. The good news is All of the products we mentioned, there are three series, some in the 7060 series, some in the 7300 series, all of them support not just 400 gigs, but also 200 gigs. So we are aware of the needs in certain cases of 200 gigs and are very, very well poised to actually grow or benefit from that as well.

Great. Thank you, Simon.

Your next question comes from the line of Woo Jin Ho from Bloomberg Intelligence. Your line is open. Oh, great. Thank you for squeezing me in. So an intermediate term technology question here. So the chip question is for Matt. So NVIDIA and Marvell have been talking a lot about DPUs in the data center. It sounds as if the data center is starting to get a little bit more complex, or the architectures at least.

Does DPUs present a port growth opportunity for you in the cloud that we may not have considered in the past?

This is a bit too early to say whether DPUs will come disrupt or is it a lot of marketing in terms of offload engines. Remember, offload engines, especially on servers, have been around for many, many years, and these might have special instruction sets for the new types of offloads the world is looking at. So, so far, we don't see any major impact to networking like us, maybe even a benefit because that drives change in architecture and actually helps us compared from the incumbency.

Yeah, I think they generally have been co-processors. They don't take away the need for a CPU.

Great. Thank you.

Thanks, Eugene.

Your final question comes from the line of John Lopez from Vertical Group. Your line is open. Thanks so much. Can you guys hear me okay?

Yeah.

Yeah, John.

Yeah, John, we can hear you.

Hey, hey. Great, thanks. Sorry, I just had one clarification for Ida on the deferred side. The deferred has gone marginally lower sequentially each of the last two quarters. And I just want to make sure I understand, are there tips and takes in that? Is that now more, say, dependent on larger renewals that happen periodically through the course of the year? So if you can just talk a second about that.

And also, is there anything in that trending that we should think about as we think about services revenue in 2021?

Yeah, that's exactly what it is, right? I mean, it's almost all services now, and it's really going to move around more by the term and the timing of those renewals, right? Whether I renew one year or three years, it doesn't really make any difference to the business, but it will show up in that deferred revenue line item, right? The revenue will still be pretty consistent, right, because you're recognizing it over time. But the deferred line will move around, right? So if you have a big renewal on a The monthly year contract, that number is going to go up. If we renew just one year and come back to do the next later, it won't increase or it might decline slightly because we're recognizing some of that revenue. So it's going to move around a bit, but it's not a business driver, right? It's just more how are we negotiating and closing out.

Yeah, perfect. Okay, thanks for the help. Thanks, John. This concludes the Arista Q3 2020 earnings call. We have posted a presentation which provides additional information on our fiscal results, which you can access on the investor section of our website. Thank you for joining us today, and everybody, please be safe.

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