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

Good afternoon, and thanks for joining our fireside chat. I'm Jason Ader from William Blair, and I'm pleased to introduce Ita Brennan, CFO of Arista Networks; and Charles Yager, Director of Product and Investor Advocacy. Before we begin, I'm required to inform you that a complete list of research disclosures or potential conflicts of interest is available on our website at williamblair.com. Also, if you have a question, please put it in the chat, and I will get to as many of them as I can. With that out of the way. Ita and Charles. Thanks for being with us today.

Yes, pleasure. Happy to be here.

Now you guys are coming off of a strong Q1, Ita. What has driven the rebound in your business? And what gives you confidence that this isn't just a temporary post-COVID bounce?

Yes. I mean I think when we look at the first quarter, I mean, we saw good strength across kind of all of the business sectors. And if you break that down a little bit, I think enterprise has been strong for us now for multiple years at this stage, where we've just seen this kind of consistent kind of execution on the enterprise side. We saw that fall off a little bit right at the beginning of 2020, Q1 with COVID. But it really after that kind of came back, performed well through 2020. So I think for the enterprise side, it's been more just consistent execution against the enterprise strategy, adding some new logos, taking some share, growing that business. I don't know that we saw kind of a pre-COVID level or that we're seeing a post-COVID kind of change in that business, right? I think when you think about cloud with the cloud titans, I mean, certainly, you had seen -- we'll go back to Q4 '19 and into 2020, some -- as overall industry slowing in their spend, and that impacted us as well. I think kind of starting in Q4, we started to see some recovery in that. And I think we're back to seeing that kind of our cloud demand is healthy, and that we think their spending levels are more healthy now. Is that COVID related? I think it's probably more just the demand in their business and the some of the product cycles that we're heading into. And then I think the provider businesses also grew in Q1, again, coming off of kind of a period where it had been sluggish. We're again, we're starting to see kind of the cloud part of that business I think, respond to a similar way to the cloud titans. And then even service provider has started to kind of grow again a little bit as we came through Q1.

And on the provider side, I know you had talked about a year ago about some sluggish just there based upon some of those providers kind of not spending on their own data centers and outsourcing some of their hosting to the big guys? What's happened there? What are the current dynamics in that space?

Yes. I mean we definitely saw some kind of rightsizing of some of those businesses. Either focusing, deciding what they were going to focus on within their businesses or, in some cases, it was kind of moving some stuff to public cloud and just re kind of deciding how -- where they wanted to play certain workloads. Once we got through that, which is kind of again, back end of '19 kind of time frame, I think we've seen those kind of resized businesses, if you like, return to growth. That vertical grew nicely or piece of that vertical, grew nicely again in Q1 for us.

Got you. Okay. So kind of getting more back to normal?

Yes. Yes. Yes.

Yes. All right. And then on the supply demand side, I know this is a tricky situation right now, but how is this affecting Arista's business and your guidance for the year?

Yes. I mean things are definitely tight on the supply side. And you see certainly lead times that we haven't seen, certainly, I haven't seen on some components out to 52-week lead times and some key components. And again, it's across not just kind of the networking, tech space, but it's even broader than that, right? And I think it really is an industry dynamic. We were fortunate we had started to kind of buffer some of those components earlier because of COVID, but we still weren't contemplating where we are today, right, and the kind of lead times that we're seeing today. So it's definitely extending our lead times as well to customers. And so supply is playing a bigger role. When you think about the second half of the year and visibility to the second half of the year, supply is definitely playing a bigger role there than it normally would in terms of how -- the visibility that we have through the end of the year. So I think we have good plans in place. We're executing against those, but there is a lot of kind of blocking and tackling that goes into just managing the supply chain right now. And therefore, we'll just watch it as we go quarter-by-quarter. But yes, it's -- we're making some progress, but it's just a lot of moving pieces.

Got you. And you talked about coming into the year, somewhere around like 15% top line growth for the year. It was a more consensus was...

Yes in the 15%. Yes.

And you kind of bless that 15%-ish number. And now you just outperformed nicely in Q1. You guided nicely up for Q2. But it sounds like you don't really want to get too far ahead of that 15% right now, just given that supply constraint situation. Is that right?

Yes. I think there's probably 2 things. I mean I'm not sure we want to be in a position where we're guiding the year every quarter just from an IR perspective in any case. But then certainly, the supply, while -- the positive is, I think the demand visibility is probably better. And we've seen some strength there. There is some uncertainty around the supply and just the timing of the supply. So I think that's kind of warrants as kind of taking in the quarter at a time.

Fair enough. Okay. And can you just remind us of the segments in your business between cloud titans, enterprise and providers, what's the breakdown there? And then maybe some of the largest customers kind of across each of those segments?

Yes. So we've been talking about the business more recently in 3 sectors, right? One is the cloud titans. The other is kind of enterprise, which encompasses the financials' vertical as well. And then the rest is kind of the providers, which is service provider and then other providers being pretty much everything else in the business, right, the specialty cloud and other businesses, right? The cloud and enterprise have both been kind of ranging in this 35% to 39% with the providers kind of making up the difference. So really, the enterprise and cloud businesses now are of equal size. And have been for the last couple of quarters. So I think that's very significant that we've actually grown that enterprise business to be equal size to the cloud titans at this point. Within the cloud business, obviously, our largest customer is Microsoft. It's been greater than 10% customer for many years now and was again a 20 -- I think it was 23% customer in the year just gone. Facebook is probably the next largest customer that we talk about a lot. They were a greater than 10% customer in 2019, but we're now [ opting ] 2020, right? So that business has been a little bit more volatile than what we've seen with Microsoft. And then outside of that, when you think about large customers, I mean, we have larger customers across the various sub verticals, whether it's financials. Some high-tech companies fit into that kind of top, you think of any quarter in any quarter on a top 10 basis, you're going to see a good mix of other customers pop in across the various verticals and then kind of it will be a different set, probably the following quarter. So it's a little bit more diversified once you kind of go outside of those 2 large customers.

But this -- on the enterprise side, these are typically big companies that you're selling into, correct?

Yes. I mean our approach in enterprise has always been to look at kind of those larger enterprise accounts where IT is really important to the business, and they have kind of a reasonable IT footprint, an IT organization to be able to really evaluate kind of the products and engage in kind of the overall architecture. So it's always tended to be the kind of those larger enterprises where you're really selling the data center footprint initially. Leveraging kind of that direct sales force, direct tech sales interaction. And then expanding out from that data center footprint to some of the other adjacent products, but it's really been a -- our target market and the enterprise is really those larger enterprises still.

Okay. Great. Let's talk about the cloud vertical for a couple of minutes, the cloud titan vertical, I should say. Can you just maybe rewind to, let's say, 2018 and then walk us forward in terms of what's happened to this customer segment for you guys? Because I know there was some volatility, especially in 2019 and 2020? And just maybe walk us through from your perspective, what happened?

Yes. I mean I think, look, this vertical had been a vertical that was growing very consistently. And for various reasons, we have product cycles, expanding, just expanding businesses and expanding geographical footprint and put in a lot of aggressive spending and footprint adds, especially around that 2017, 2018 time frame, where you had a 100-gig product cycle, you had new capabilities around routing and switch routing capabilities, et cetera. So it was just -- it was a very strong cycle for us. It was a very strong cycle for their investments in their overall networking data center footprint. I think coming through the end of 2019 is probably the first time at an industry level that you've seen kind of the spending, network spending by that part of the market actually decline in Q4 of '19 for the first time, and we saw that as well. And it had remained somewhat muted through 2020. And again, that's an industry story, and it was -- as a result, was an Arista story for that piece of the business. I think we have seen spending start to rebound from that part of the business. Q4 into Q1, I think we've coming -- we've been becoming incrementally happier with what we're seeing from a spend level with that part of the business. So I think we saw some cyclicality, probably for the first time, really certainly from our perspective in that business. But I think now you're starting to see that kind of return, and it's been pretty broad-based from those customers.

Do you think it's product cycle driven or something else? Or it's just that maybe some digestion and now they have to kind of get back up on -- turn the spigot back on?

Yes. It's probably a little bit of both, right? I mean, I think you have you definitely had some digestion, I think, coming out of that back-end of '19, early '20 but their businesses have been doing really well through COVID. Obviously, they probably consumed -- if there was available capacity, they've consumed it. So I think there's some of that. And then we are kind of getting to the -- heading into product cycle again around kind of this 100, 200, 400-gig products, different capacities for different customers but all really being driven by the same kind of underlying silicon product cycle.

And what was the comment that you made on visibility? Usually, you have something like 1 or 2 quarters, and you said that's been stretched out? Maybe elaborate on that for us.

Yes. I think as we partner with these customers to try to lay out match the supply to their real demand and implementation schedules. I mean, they are providing more visibility than what we've seen previously. And we've had -- before, we would have seen maybe a quarter worth of orders and then some project-related kind of visibility. We're getting a little bit more granularity, a little bit longer, more detail around what are their priorities so that we can match with those, right? And we're providing visibility to what we are doing in the supply chain to make sure that we can respond and they're providing some more visibility around what their more urgent, prioritized needs are. So that's just giving us a little bit more, I would say, detailed visibility and a little bit more project level visibility than what we normally have.

Right. And you're not concerned that they're double ordering or trying to kind of preorder because of supply issues or supply concerns?

Yes, I think we've established kind of the process that says, give us visibility to what you're essentially planning to do and when and we'll return that kind of transparency to what we're doing. So I think there's a fair amount of transparency back and forth. I mean, at least for our larger customers, which are still a reasonable part of the business, that kind of interaction is happening at various levels of the organization, just working on kind of what needs to happen first and driving to real deployment schedules. So I think that helps. I mean, it's not to say that it's perfect. But when you can touch those larger customers, you can get some confidence around it, you understand when they really want to deploy across some of these bigger customers.

Great. And then just from a competitive standpoint, I know your competitor in San Jose has been talking a lot about some share gains in the cloud titan vertical. What have you seen out of those guys? What have you seen out of other competitors? What have you seen on a white box, maybe just kind of lay the land right now from a competitive standpoint?

Yes. No, I think, look, we talked about this a bit on the last call as well. I think we're really comfortable with kind of where we ended up as we've gone through the cycle with these customers, right? I think there's been a lot of noise, a lot of discussions. It is a dual-source, multi-vendor environment. It always has been. But I think now that we've gone through qualifications and seen some pilot builds, et cetera, I think we feel good that we'll have a healthy share of their spend as we go into this next cycle, right? And that's -- I think that's a testament to the product and to the work the team has done in terms of engaging and the execution on the multiyear execution that we have there. So I think there's always going to be multi vendors in these environments, whether it's white box, whether it's a competitor, but I think we feel good about where we've come out and our share of that, their spend as we go forward. And then it's just a question of what does their spending look like. and what's the -- what is the spend over time?