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

Thank you. Thanks for hanging out this afternoon. I know there's some blackjack tables downstairs and I'm sure people are waiting to get to, but I appreciate you guys taking the time. And extremely pleased to have with us on stage Anshul Sadana, the Chief Operating Officer of Arista Networks. Anshul?

Aaron, I don't know if you pick the music or that was…

That was perfect coincidence.

Yeah. That's great.

So thanks for joining us. Looking-forward to the conversation. I wanted to just start just talking a little bit about the evolution of Arista. You guys recently and if anybody's has not seen the slide deck from the Analyst Day that they hosted a great Analyst Day event, just a month or so go. But one of the things the messages I felt coming out of the Company was that the company started as a product company, right, and you are evolving into a much bigger platform Company. So maybe that at a high level, maybe you can help us appreciate what that means, what that evolution looks like as we think about the next five years or whatever it might be time horizon-wise on that platform journey for the Company.

Absolutely. Aaron, when we started, we were very focused on just datacenter switches. And all of you largely have thought about us as a hardware box company, we sell boxes with some software on it and that software is fairly complex. It's about EOS and CloudVision. EOS is our operating system, added together at least 25 million lines of code today and is highly programmable and a very, very high quality stack. When you look at IT operations and networking as part of IT operations, no longer just a silo. It has to be fully integrated with everything that the teams are doing, because provisioning and automation and security and business outcomes are all inter-related. So the way we have developed our stack is now to a point where EOS is truly becoming a platform. You can run it on any of the hardware we have, but in the end, you can program it. You can use it the way you want. CloudVision, which is our automation stack is not just about automating the network, now we are helping enterprises automate the automation. There's more integration, outbound integration happening between CloudVision and all the other provisioning systems that exist. So getting into the deep glue of enterprise IP. That's where this is truly becoming a platform. And it's easy for people to deploy it. They love the product already and I think we have long ways to go from here into many of the other use cases that are all adjacent from right here.

Yeah. And that kind of -- you mentioned CloudVision, but EOS stickiness of what you're doing everything wraps around EOS, right? I mean, it's unmodified Linux kernel, how far can you take this? So maybe talk a little bit about some of the adjacencies that you're most excited about right now.

I would say one thing about EOS that is maybe not always appreciated is, how do we get the high quality. The architecture is already great. That's foundational to everything that we build. But the way networking has worked in the industry for decades is you write a feature then you throw the ball to a test team and they will test it. And they'll find some bugs, they file the bugs, then the development team fixes the bugs. Then you test a little bit more, then you ship the product to the customer. The way we think of this is, how do you build a test framework where the product always works. So instead of having thousands of QA engineers, the size of the test team, the QA team at Arista today is 8 megawatts. Our software development team writes all the test cases, fully automated infrastructure, we scale that to a point, where we run about 150,000 test cases every day on every product on every release we've ever shipped. And that keeps on improving on its own, because if there's a bug you're likely to find it. And then you have the test case and that will never escape again to our customer, very different than what our competition has been doing for two or three decades. When you take that, that's why customers love it. It just works. And now look at other use cases. We constantly get pulled by our customers into other segments saying if I can run EOS and CloudVision, why can't you do campus networking for me? And that's really how we got into campus. There is enough pull from the customer, enough interest in there. The same thing is now happening in a little bit in the router and WAN environment, not just inside the building, but how do you leave the building, how do you go out, there is good opportunities there. We've already been doing some of the work in routing with our cloud customers and some of the service providers who can apply this to enterprises as well. And the same is true in applying other layers on top. For example, Awake and NDR is a massive strength in our product portfolio. That's never going to be the primary revenue driver. But what we do with our network detection and response system is build a network, where you can detect threats based on what's going through the network. And that's just an extra layer of protection that today doesn't exist. The customers love that as well and that's integrated into the campus product from day one. When you buy an Arista Campus Switch, it has threat detection already built in. You turn on a license and you get that feature and so on. So I think there's a lot to be done there and that's how we grow in the adjacencies too.

Yeah. And put that to kind of that. When you think about that competitively, the competitors are still fragmented across their product portfolio. So from a competitive perspective, the durability of what you're talking about appears extremely strong, right. You don't see the competitive landscape being able to moderate or change their path forward, very effectively to compete against a single operating system approach.

I think they all obviously tried, right? We have some good competitors as well. So it's not as if this is an industry that lacks and there's no competition. It's very intense competition. But to a great extent, you're right. I think our competition slides are always ahead of the executions, because our execution is ahead and we want to keep it that way.

Yeah. So shift gears a little bit. So I don't think you'd ever get into a discussion with a financial analyst that wouldn't ask you about the demand environment. And one of the things that we're seeing in networking is this kind of question of networking spend seems to be so far fairly resilient and there has been some concern and choppiness overall macro dynamics and stuff like that. So as you look at it, how are you currently see or how would you characterize the demand environment and certainly segueing that into kind of the visibility that you see from the customers as you engage with them?

Yeah. Whenever there's crisis, everyone has to prioritize. And today, there might be a macro event already happening. But in the end, companies cut back on free lunch and drinks and free laundry, not on networking, because networking is essential. You cannot really make do of your business and run your workloads without enough bandwidth and the right connectivity and security and so on in between. We're already seeing that. Our customers are telling us, this is critical to the infrastructure. In addition, I think networking is this one place where we glue everything together and if it become a bottleneck, it significantly reduces the efficiency of the entire infrastructure. We're already spending so much on computer storage or other things. You might as well spend a little bit more to have ample bandwidth in between the right connectivity, the right segmentation, so that you don't disrupt any of your business close. So we are seeing some of that. The same applies to cloud companies. Cloud companies, might slow down in how many racks they are adding to their datacenter depending on demand, but they do not slow down in DCI build-out, if they have to build a new region they will do the DCI build-out upfront, the data center interconnect to get to the right outcome for that regions. We are seeing healthy demand as a result of that for networking and specifically our products.

And how about that same kind of question, succinctly to the enterprise piece of the business? That's one thing in the Arista story, I mean a lot of people ask you about the cloud and I'm certain that we'll talk more about the cloud, but the enterprise momentum that you've seen has been fairly remarkable. How would you characterize the enterprise demand environment that you're seeing right now?

So look, for enterprise, there are two big pieces of our business; one is enterprise datacenter. It continues to be healthy. We've seen good growth. We continue to see good growth over there. You have Campus which we say call it as an adjacency, but it's growing really well. It's starting to near roughly 10% of our annual revenue. So to some point in the near-future it may not be just an adjacency, it will become our core business, it's growing very, very well. Because of the way we are exposed to large enterprises, which I think either field macro event later and cycle or certainly don't try to cut back as much or Campus we have such little penetration and good growth that we won't feel the macro upfront. I think we will be the last company to find out there's been a macro event not the first one. That demand has been good and sales teams are opportunistic, right. They'll find the customer that is still willing to spend a lot of money and sees that as a best opportunity. What's happening in Campus is there was this debate during COVID on do you upgrade or replace the campus or not, because people are not coming back to the office. But now it turns south, that even if you come back to the office one day a week you still need that network to work, because when you sit there, what are you going to do. You're going to do video conferencing all day with all of your colleagues all over the world. So you have to invest in that network and infrastructure and upgrade no matter what, which is what many enterprises are doing as well.

I don't know if you guys ever talked about this, let me ask the question anyway. How much of your business comes from what you would characterize as kind of infrastructure refresh or replacements versus net new footprint build-outs? And obviously, that applies probably to the cloud vertical, in particular, but just curious how you think about that mix of business for rest of that.

This is something that's extremely hard to measure for us or for anyone else. I'll put that out of the caution, do not try to infer this into some mathematical model that immediately results and this is what the spend is going to be. It varies quite a bit by customer as well. But the way to think about the cloud, even the supplies to the enterprise as well and the enterprise I think the math is fairly straightforward that datacenters, they try to refresh between five to seven years. If there's supply shortage, then it becomes seven years. If there is business shortage, they will try to do maybe five, six years. But at least that duration, they're not going to replace prior to that. Campus environments people have spread their assets much longer. At least this one analyst report we've seen where the average life of our Campus Switch that's deployed somewhere in the world today, it might be between 10 to 12 years, that's been sitting out there that long. Cloud on the other hand does refresh a little bit faster and they need the efficiency too. But the way to think about the cloud is you have DCI, the data center interconnect and the backbone, the primary job is to spend as much traffic as possible or longer distances, longest could be 100 kilometer or thousands of kilometers. So this is newer technology that can get you from 100 to 400 gig, they deploy that quickly. But if they have just deployed 100 gig last year, they're not going to retrofit that immediately with 400 gig as an example. They're going to wait at least three, four years before they even up cycles to go back and revisit that site. But compute is a bit harder to understand. On average, cloud companies also would like to refresh or upgrade every five years or so. So on a simple math basis, one-fifth of the infrastructure should get upgraded every year. But what happens is, whatever is high-end of compute being sold today, two years from now will be sold as mid-range compute and five years from now, it will be sold as low-end. There is a lot of reuse that happens. And depending on the SKU and the architecture, the reuse is succeeding or not, models actually vary a lot. On top of that, you put supply shortages and they haven't managed to work the way this has became wishful thinking that I would also like to refresh when there is such shortage. So as a result, some of these things got pushed out. But it does vary by customer. But that's the overall goal that they're trying to get to, try to get there roughly every five, six years or so.

So shifting to the next topic, which is I think you alluded to that a little bit in the response here, but you have a tendency to talk probably a lot about 400 gig, a little bit. I'm curious of Arista's positioning at 400 gig. I think you gave some market share metrics at the Analyst Day, but maybe help us appreciate you being able to maybe even take share to 400 gig cycle, where do you think we're at in the 400 gig cycle and I'm definitely going to ask you about 800 using 1.6 after that.

So lots of assumptions in that question. I think that I'm really glad you're asking this, because this perception that the sub 400 gig cycle. What if there is no 400 gig cycle. The cloud are deploying 100 gig in high volume. We showed this at the Analyst Day as well that 100 gig actually continues for the next five to seven years, it doesn't really slow-down much. On top of that, you have 400 gigs for certain use cases and those use cases today are datacenter interconnect, our backbone as well as AI. And the sort of DCI has been going on based on availability of 400 gig products and ZR optics mix with that. AI is somewhat newer relative to DCI, but still starting to happen. But customers will continue to deploy more efficient 100 gig for a couple of years to come. So 400 gig really gets layered on top. It's not a cycle by itself, it's getting added on top and we have done phenomenally well I would say in our execution, with our key customers, our top cloud customers, some of the Tier 2 cloud as well and they are extremely happy with us. This whole notion that someone puts out an announcement that just because they finally made a product that somehow they takeaway 100% of the share, it's just not true. I talked about the 25 million lines of code in lot of those lines of code was written based on requirements by the cloud companies. It will take some of our competitors a decade to catch-up to all of that and the automation and the APIs and the streaming telemetry and so on. But customers do want to be multi-vendor and often that got confused for someone else is going to take away a lot of share. We've done very well in 400 gig so far. I think the market analyst reports have been published up to Q2 or Q3 results of this year and we have the number one market share in 400 gig ports globally in the OEM vendors. There are two cloud companies in the US, but with their own white boxes, they continue to do so, but they own 400 gig products. So if you exclude that, we are doing significantly better than our competition, but at the same time, we're also maintaining a very strong share the number one position, almost 40% plus market share in 100 gig as well and on top of that in 400 gig. So I think this is good execution by the entire team at Arista, and especially with the cloud vertical and some of the high end, high tech.

And you mentioned and I'll segue off that, answer that question a little bit, it always seems to come up this fast, the white box competition, right. And you've been fairly candidate in the past about how you see it evolving and I think you just mentioned a little bit the lines of code and how you work very tightly with these cloud customers is an important attribute when we think about that white box risks competitively. Just maybe for the audience, share your thoughts on white box. How you see that competitively, if at all.

You know, Aaron, this question has been on the table since our IPO. This was the number one risk flagged at our IPO that somehow we will lose all our business to white boxes. What you have to understand is, why do these cloud companies use white boxes in the first place. And for every company, the decisions they have made at the time, they've made them have been different reasons. Google did this in 2005. Guess what, there wasn't any competition in the market at that point, they looked at one networking company and asked them, hey, can you give us a very large network at the right price? They said, we can't, built it on their own. Amazon, looked at this whole space in 2010. In fact, they talked to us at that time, but we were a very tiny start-up. So they didn't really think AWS could run on infrastructure from a start-up. They decided, they would build on their own and they have religion and vertical integration if you didn't know. So they really do like to build everything on their own or buy their own planes and ships and build their own switches, when they can and good for them, right? They can get the right results, they have the scale to put the investment into that. Come 2013-2014, when Facebook or Meta had to make that decision, they had a different viewpoint. They said, you know what, the market is a lot more competitive now. They talked to us, they said, let's partner and you saw the result of that in the first switch that came out around 2017-2018 with Tomahawk 1 and that was the product -- Tomahawk 3 was the product where essentially, the two companies co-developed it together, so it went from build versus buy to build and buy. Team is extremely happy with the outcome, because they are multi-sourced, they get all of their requirements matched to their datacenter spec. During the supply chain crisis, there were so thankful that we were there for them to give them the supply we could and the deliveries we could and so on. You look at Microsoft, our biggest customer. And they've looked at other cloud companies too and realized you know what, if Arista's competitive and be able to supply all this gear to them and meet every use case from top of rack to spine to DCI to WAN to Edge and so on, then why go through the pain of building something on of our own only to not even sort of be as competitive, maybe somewhat behind and it's not worthwhile. So all these companies have made the decision that in today's time, it makes sense to not build on their own but buy from the industry, because the industry is extremely competitive. But the ones that we're building on their own won't easily go back to buying from the industry, because they're locked into their own start with the right software development, 10, 15 years, as I mentioned, 25 million lines of code in US, guess what, these cloud companies have millions of lines of code in their own stack as well. Who is going to port all of that book, which is why I think this entire industry remains largely status quo. There might be a plus-minus 5% shift here and there and there is not going to be a massive shift in either direction. I think it's a misconception for anyone to think there is risk. If anything, I have mentioned this on one of the earnings calls as well, with at least one large cloud company for a few use cases, not everything, but for a few use cases is considering going from white boxes to buying from the industry. So if anything, it's actually going the other way not more towards white boxes.

You just answered the question I was going to ask, because I thought that why not the reverse. So you're seeing at least one hyperscale cloud customer.

Few cases, because they have additional functionality that's required. That doesn't exist in the internal stack, it will take them too long to build it. At the same time, they will go through the process and converting and actually using products from the outside in places they've never done so before. So they have to change their controller logic, the upstream, not on software stack has to adapt to that as well. We'll see if that happens or not, but certainly I don't see any of these companies saying, you know what, we have done and we will only build white boxes.

Yeah. We talked about 400 gig.

Can I add one thing here?

Absolutely.

We had lots of one-on-ones today. This was the number one topic today, this has been number one topic for the last 10 years. So, on white boxes for some of our largest cloud customers today, we are working with them on their architectures from 2025 to 2027. And in places where we are deeply entrenched, we are working on, how do you cool 1,000 watt chip and still keep it efficient for the customer. How do you get the signal integrity on a standard PCB technology for six-seven inches of traces that 100 gig SODs and 200 gig SODs, which are the NextGen speeds. And our customers are amazed by the contribution that our teams are able to bring to the table. And as a result of that they have no interest trying to all of this by themselves. And many of you don't see discussions and meetings are happening that are three, five, seven years out. We are in these meetings daily, which is why we are so confident that these customer bases are not going to go back to white boxes, they actually need us to develop all of this and get there as quickly as possible.

Extremely interesting. I've got 35 more questions in little under nine minutes.

I thought we'd only about white box.

So I think this question is going to tie together a little bit. At the Analyst Day, your colleague Andy Bechtolsheim, one of the Co-Founders of the company gave as always a very good presentation overview, talked about 800-gig and 1.6 being maybe even faster cycles and I'm going to dovetail this within the context of AI Fabric networks, right. This idea that as we see more GPUs attached in servers, they're consuming just a massive amount more bandwidth, maybe connect the dots there, AI fabrics the Arista opportunity and again kind of help us appreciate how that's being driven by GPUs.

Absolutely. Around 2012-2014 timeframe, IP storage or Ethernet Networks was a very big deal. You have to do and unlock this way and 40 gig was just coming onto the market, but it wasn't enough. The pipe got saturated very, very quickly with storage traffic, then came 100 gig and everyone was so relaxed. Finally there's enough network IO that I'm not congested and dropping traffic whole day. The same thing is happening with AI today. At 100 gig speed or even 400 gig speed, the AI workloads just consume all the bandwidth and you are still congested and dropping. And the reason this matters is the way AI works is, if you have a 1,000 node cluster, there are 1,000 GPUs. You're doing a transformation of a dataset and if one of the nodes is still not done because we need some pockets to come back, all the other 999 nodes are waiting, waiting for that transaction to complete. Facebook or Meta published a paper on this and they showed that most of the GPUs for many of the AI benchmarks are waiting on network IO to complete for a third of their cycles. 33% of GPUs are completely wasted. So if you give them more bandwidth, they could do the same job in the same amount of time with only 66% of the GPUs or they can finance the entire job in 66% of the time, if you give them all the GPUs. But in any way to look at it can be a lot more efficient and a significant cost saving. So all these companies, the AI groups within these companies are coming to us and every other company is saying can I go faster. That's where the need for 800 gig comes up. Those are the company is sitting down with us and talking about 200 gig SODs, which are not even coming to the market now. They'll come back two, three, four years from now, best case. And they want to start designing that now because they know that as soon as 1.6T comes to the market, they can consume it. There's immense opportunity. The AI clusters are already starting to get large. And when they get larger you need a nice systematic network that works, you can monitor it, you can provision it, you can automate it. There's nothing better than the IP leaf-spine designs we've done so-far, but now tuned towards AI workloads and get the right monitoring and buffering and other mechanisms in there. And as a result of that beginning pulled into a lot of these opportunities. I think AI high speed Ethernet, IP will all converge with every generation of technology that comes out now.

I think at the Analyst Day, you guys talked about that representing a $2 billion to $3 billion adjacent market opportunity for the company, arguably in the very early innings of seeing that opportunity materialize. I guess where I get confused, little bit sometimes is, how does -- what you're talking about Ethernet side, where does InfiniBand fit-in or is it Ethernet versus InfiniBand or both coincide in the context of AI Fabric network build-outs, so where is the delineation there, if there is any.

Well, there are certain workloads that are latency-sensitive and SBC environment is like the top 500 clusters, many of them use InfiniBand for that reason. But the many workloads we are seeing in the large public-cloud that are not latency-sensitive, but they need a loss-less network, they are IO sensitive, you cannot drop a packet. If you give them a better Ethernet network like we have with our AI spine which has very deep packet buffers, give you a contrast an average top-of-rack switch today has about 32 megabytes of packet memory and we're trying to get all the pocket through without dropping this congestion you buffer them up into 32 megabytes. The AI spine we have like the 7800 as 8 gigabytes of packet memory per chip. That's a lot more packet memory than you would imagine, but you need that to have that completely loss-less architecture, that's the kind of trade-off that you're looking at. It will start cost a little bit more, but in the end, if you can see one GPUs, why not. So I think that's why we are headed towards these architectures in a way that nothing else can scale to right, you can build a 256 node InfiniBand cluster but if someone says can you break-out 32,000 node cluster and operate it like a cloud and just not have to bring down the whole cluster for maintenance and upgrades and on, you need to be back into the leaf-spine type of architecture we've done a distributed mechanism essentially to really scale this up.

So it's interesting we've seen obviously Meta's has made some fairly public announcements around their AI RSC deployment, a big driver of their CapEx spend. We've seen recently NVIDIA announce the collaboration, multi-year collaboration talking about multi thousands of GPUs deployed in the AI projects. When we see those kind of things, do we think, hey, those are net-new adjacent network build-out said that obviously as part of that $2 billion to $3 billion TAM opportunity that's starting to materialize for Arista.

Absolutely. I think as you see more AI move to the cloud, that's a great opportunity for Arista. That's in a nutshell, how you can measure it. The specifics are different business cluster, Meta has different types of architectures, [indiscernible] different types of architectures and so on.

Okay. In the two minutes we've got left, I want to ask you about software strategy, right. At the heart of it at the end of the day, Arista was founded on the software differentiation as far as the strategy and you've obviously talked about expanding in adjacencies around that core software. How does the company think about monetizing software? Is there an evolutionary path, where we start to think about Arista being a software-centric line-item subscription line-item, just curious as to how you guys thinking about that internally.

Yeah. So the software line-item is actually quite significant already, but the way to think of software subscription or a SaaS model is that you're delivering value where the customer appreciates the subscription model, they can turn it on, turn it off, number of seats, number of features and so on at any given time and they're getting constant value every month, every quarter, every period with updates, then a subscription model is justified. In places like CloudVision, CloudVision is pretty much offered only as a subscription product to our customers. And it can run on-prem or in the cloud and when it runs on the cloud, you have significant value and how we manage CloudVision for our customers, so that's what they manage and run and automate their infrastructure. But it's all offer as a SaaS model. We have our licenses for routing and so on that are a line item they get added on, if you want to turn on more functionality on the switches, you're paying more for the product as well. What we don't like to do is, do an unnecessary conversion of hardware to subscription to show it like subscription. That's essentially a leasing model. There's no real value to the customer other than telling them, you need to pay more if you keep on using the product longer. That's not what they like, because they think they are buying something else perpetual. So I think that's somewhere in-between. They're not trying to do an artificial shift just to please Wall Street. I think it has to be organic in your business and then the results will show. You see this in CloudVision, you see this in Awake part of our business, you see this in our DANZ Monitoring Fabric. These are all subscription offerings.

In the 45 seconds we do have left, I mean is there anything that I didn't ask you if there's any comments you might have on supply-chain dynamics or anything else that maybe we should have asked you or takeaway from this discussion?

Look, supply will recover. We've said this in earnings calls as well probably towards the end of '23 is our best case guess, but let's see what happens to the whole world. Best opportunity in front of us is still growth. Cloud has long-term systematic growth. This is a sector that has ups and downs. It comes with the segment, we can't ignore it. But at the same time, when I ask the cloud customers what are their plan for the next 10, 15, 20 years, they just see growth. Enterprise, datacenter, we are still underpenetrated. Campus, we're just starting. It's tremendous growth opportunity and I get as excited as I was at the time of the IPO that we still see that growth and great opportunity to keep on taking share.

Perfect. Anshul, we're right on time. Thank you so much for joining us.

Thank you, Aaron.