Arista Networks, Inc. (ANET) Earnings Call Transcript & Summary

All right. Well, good morning. Thank you all for joining us. For those of you who don't know me, I am Erik Suppiger, the cybersecurity and IT infrastructure analyst for JMP. And for this morning's session, we have Arista Networks. To my immediate right is Chuck Elliott.

Charles Yager.

Here we go. Charles Yager, Investor Advocacy, and we got Ita Brennan, CFO.

I'm going to start it off with some of my questions, but I want to make sure everybody is comfortable raising your hand. We would certainly encourage you to ask any of your own questions. The object here is to make sure that our clients have an opportunity to take care of any questions and concerns. So we were just discussing a couple of the, kind of, topics of the day have been coronavirus and what that means. Extreme Networks just published an 8-K this morning, basically preannouncing their quarter and that they are talking about component issues in their supply chain. So the question I have is, one, are there any further indications that you want to discuss. You only had your earnings call about 10 days ago. But is there any perspective in light of -- what they had talked about was a very slow ramp-up from the Lunar New Year in China. And then if you look out, what do you think the greatest risk that coronavirus represents in terms of your operations?

Yes. I mean, I don't know that we have anything new to add at this point. It's only been, to your point, less than a couple of weeks since we did the call. We don't have any direct manufacturing footprints in China. But obviously, we do have some supply chain impacts that -- there's a lot of those components and subcomponents that are manufactured in China. So it's a question of working through piece by piece, right? There's a lot of detailed work that's ongoing now. Planning for various outcomes and understanding where we're at in terms of near-term supply. But there's, obviously, supply in the supply chain already, which will help. And then it's a question of just blocking and tackling around every single component and understanding where they are. I mean it's changing, obviously. Some factors are coming up. They're coming up at different schedules. So it really is just a -- it's a supply chain -- detailed supply chain exercise to go figure out exactly where we are, and then look at alternatives, and plan out for some period of time. And that's all in play now. But we don't really have anything new to add from what we said on the call, which is we don't have a direct manufacturing footprint there. We do have some existing supply chain availability, and then we'll go figure out where we are from there.

How do you manage the inventory? Do you -- you have a lot of finished goods, I think, that you maintain. Do you keep your components, raw materials on your balance sheet? Or is that more of the contract manufacturers? Or how do you -- how do you stockpile inventory, if you see a situation like this?

Yes. I mean we hold raw materials. You can see that in the financials of some key components ourselves. And maybe that's because there's long lead times, and we'll want to buffer more than your average contract manufacturer will want to hold. The rest is through the contract manufacturer supply chain. It's more kind of, I would say, common components as lower value components.

And does Arista do, I think, for your chassis, you do some made -- you do a fair amount of made-to-order as opposed to stockpiling finished goods? Or how should we think about your inventory, the way you manage your inventory?

Yes. No, I think we will always have some build plans that build to forecast. And it's not -- so it's not a build-to-order model, and it will have various strategies rather than various components. I don't know that I want to start trying to go piece by piece here, but it's definitely a build-to-forecast model.

Okay. All right. And as far as the tariffs, that was kind of the challenges of '19 -- 2019 and prior. But the tariffs, they're no longer much of an issue in terms of impacting your financials, are they?

No. I mean, we've made some changes to respond to that in the supply chain. We've shared some of the costs with customers, et cetera. So I think from a financial statement perspective, it's a much smaller impact at this point.

Okay. I want to move on to your expansion into the campus environment, campus switching. Just to give some perspective, it was a couple of quarters ago -- a few quarters ago at this point that you started your entry into the campus market. And on the most recent earnings call, you had noted that you are on track to deliver or generate $100 million in the first 12 months. We're 2 quarters into that. And then on the call, it was also referenced that you would like to double your revenues in the second year and then double again. So go from $100 million to $200 million to $400 million. What -- it was like Jayshree had made that as an aspiration. What are your thoughts on that?

Yes. I think the $100 million target was kind of revenue in the first 12 months. And then, like I said, we're making good progress there. In terms of what we've set the next kind of goal to be -- we'll probably talk more -- in more detail around the Analyst Day in terms of what that looks like, for sure. I know you'd like to see some ongoing momentum in that and I think Jayshree had talked about your run rate, if you hit the $100 million, it would obviously be more. You're ramping into that as you go through the 4 quarters. But I think in terms of setting like a hard target, we'll probably do that around our Analyst Day in the middle of the year.

And the Analyst Day is when?

We haven't set a date yet, but typically in the middle of the year.

Okay. All right. Any questions initially here. All right. So just expanding on the enterprise side of the business. Should we be thinking of your enterprise business as the biggest growth driver at this point? And to put some context around that, so much of the story for Arista has really revolved around the web titans, but that started to slow in 2019. Should we be thinking of the enterprise play? And a lot of that driven by campus as the growth driver as we look ahead?

Yes. I mean, I think it's hard to try to prioritize the verticals in terms of importance. Cloud is clearly going to be a very important part of this market going forward, and it continues to grow. We believe it will continue to grow over time, right? I think the challenge is more of what's the slope of the curve than it is. Do you fast forward multi-years from now and say, is cloud a larger piece of this market and has it grown? And I think we believe that it will grow and it's more difficult to predict the slope of the curve. That's still going to be a very important part of the market, and we absolutely want to maintain our -- the positions that we have with those accounts, and we'll continue to invest to do that, right? That said, it has shown over the last 12 months that it's a -- it can be a volatile business. And therefore, bringing up other parts of the business is important, right? And I think we've long kind of had the view that everything that was important to cloud -- to the cloud part of the customers that would eventually be important to everybody else as everybody's business model started to shift to cloud. And I think we're seeing that, and we saw that with the Thunderkick site -- cycle, where if you're an enterprise and you've got a cloud-based kind of business model, whether it's retail or health care or anything else, then you start to care about all the same performance metrics, et cetera. That allowed us to be successful in the cloud. And so I think that's what we've seen. We've seen this kind of pushdown through the various market segments. And obviously, it's earlier in the enterprise for us. We had previously targeted very -- with particular verticals like financials, like maybe those what we call high-tech enterprise, and that's really been broadening out and so now you're starting to see, I mean, in media entertainment, health care, commercial, industrial. It's a much broader set of enterprise customers now, right? So does it grow faster or slower? I don't know but that's very interesting. And if you ask Anshul, for example, what's he excited about? He's excited that those customers are finally starting to see the value of this kind of cloud-based data center structure and by extension into the campus, right?

Okay. It brings up one of the questions that I had is, how large do you think of your enterprise target market? We thought of it as predominantly being financials and then technology and some high end, maybe, education kind of sectors, but it does sound like you're taking it much more broad than the traditional enterprise that you've talked about. Is that right?

Yes. I mean, I think, if you look at the -- some of the industry analysts, now they're breaking that kind of enterprise part of the market into what they're calling large enterprises and then they have kind of a smaller enterprise. And you can see that, that smaller enterprise over time is moving to the cloud. And then the larger enterprise piece is still maintaining a good spend around data center. And I think that's the piece that we're interested in. So I think the attributes are more than being kind of delineated to a particular business, are more about being large enough where IT, the data center is kind of -- is important to their overall business model, where they have kind of an IT base of folks that can assess and evaluate products and are engaged in that, and it's really important to the business that they kind of get that right. That's the type of customer, whether it's in each of those -- any of those verticals.

So it's not so much driven by a vertical, but more on customer size and a customer's inclination to invest in their private cloud.

Right, and...

Is that how we should think about that?

That's for sure is table stakes. And then obviously, we need to make sure we're addressing anything that's specific to their particular business, right? So that was -- and media entertainment was a good example of that. I think we've extended beyond that now. So there is some level of investment we need to make by those individual verticals. But I think the starting point is you need to have a business where the data center is critical and it matters, and the upside matters and quality matters and cost of running that data center matters. If it's a business, I mean, obviously, not dissimilar to Arista, where we think the data center isn't critical and then you should be in the cloud. We don't have a data center that we run for our own internal business needs, right, because it's just not critical to what we do.

Yes. Okay. All right. Any questions so far? Okay. So in the most recent couple of quarters for Cisco, their networking business has slowed. Extreme has seen a slowdown. Juniper, I think, has seen some slowing. Do you have concerns about the enterprise market slowing at all? Or it's been a pretty distinct dichotomy between enterprise networking and what I would say is IT spending, where IT spending seems to have held up pretty healthy in the last half of '19, but enterprise networking seems like that's been a challenging market. Do you have any insights into that? Or do you have any concerns about that?

Yes. I mean, look, you can't listen to the other reports and stuff and not, at the back of your mind, have some concerns about at least what they're seeing in that market. And they are probably, by far, a bigger bellwether to that market than we are, right? On the other hand, we're starting from a small base and gaining share, right? So coming into Q4, I think we had similar commentary. Enterprise did well for us in Q4. So I think we continue to exercise that and always have a cautious eye to what's happening with macro, et cetera. But it seems like we're small enough and gaining share in that particular part of the market that we haven't kind of hit the same wall that they are hitting. But it's definitely something that we need to continue to keep an eye on.

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