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

Well, thank you, everybody, for joining us. My name is Tom Blakey. I'm the Infrastructure Technology and Software analyst here at KeyBanc, and we're grateful to have John McCool here from Arista. He's the EVP of Engineering and Operations and also the Chief Platform Officer. And we have Liz Stine from Investor Relations in front of others here in the front room. So -- well, thank you very much for joining us, John and Liz. I just wanted to start off because I think from Chief Platform Officer maybe just a minute, what does that...

Sure. I won't have to stand, Tom, because you're standing right here.

At Arista what your responsibilities?

So Chief Platform Officer, I have really 2 domains. One is hardware development. So all our new products and then manufacturing and supply chain. So effectively, I get to see products from inception and concept and then all the way through production and build out.

Excellent. Just want to jump on what we're asking all of our companies at the conference here to try to get some sort of semblance of the macro. We know things ended at the end of last year, macro softness and things kind of -- spending has gotten a little softer. I was speaking specific, I guess, the enterprise for you related to our cloud business. But as we go into the second half here, just generally speaking, what is the business kind of update in terms of -- from the beginning of this year to the second half of this year?

Sure. In terms of Arista, I'm not sure we would be typically a bellwether in enterprise. We've got a lot of share that we have to gain an opportunity. I think that's a little independent from the macro. We did talk about on our last call the success in the enterprise. That's momentum that we've built out through the last couple of years in 2 dimensions. One of it is new use cases and new products coming out from just data center, moving into routing and campus. And then we also talked about cloud was big news for us early in the supply chain challenges, I think cloud recognized that there would be impact and really prepared for the big build-out took enterprise a little bit longer. And now you're starting to see enterprise catch up in terms of our shipments and deliveries.

To segue to my next point, point of questions here about enterprise. Arista has been very successful in the high-performance data center has meaningful share there with some Gartner data, for example, has 45% market share at the high end. You mentioned the new products that you've launched in the enterprise. Companies have the ability to standardize on Arista. You had experience in Cisco. What are the dynamics that are kind of different throughout the rest of the stack that maybe Arista could -- with the ups and downs, the risks and the benefits of how Arista is going to try to emulate the success in the data center throughout the rest of the enterprise...

Enterprise, the whole picture?

Yes.

So for folks not familiar with Arista, we started out with a data center play, right? We actually started out in the financial vertical with a low latency switch. And we got a strong footing in certain verticals, financial and media entertainment around the data center solution. Then we started to build out new technologies or use cases around the solution, specifically routing. So we went from connecting your servers and building out a distribution network to being able to interconnect site-to-site and redundancy. Then we made an acquisition of WiFi and built organically our own campus switching products, which would connect end users into the network. And with Awake, we started to get into network security and detection. And then the last piece that we've built out, I think, is pretty important is WAN transit. So being able to connect remote branches back into the network. So we feel pretty good today that we have all the central building blocks for building an enterprise network end-to-end. And if you're looking at an alternate to your incumbent, you really want to see somebody that can challenge across all those use cases. And I think we're in a good position today.

Is there -- are there any additional need along the lines of you finally having this end-to-end solution technologically? Walk us through like not so much to go-to-market, but this is a market where you're taking share -- taking dollars away from something that's already installed. It's not like a software company that's starting a new TAM, if you will. How do you -- what are the technological advantages of Arista to kind of basically rip and replace some of the infrastructure that's in place with the incumbent?

Yes. I think our approach is very different. We get this question a lot, and people want to point to a differentiation in all those roles, like, okay, your campus solution. How's that better, your WAN transit solution. We take the approach that we build a better enterprise network. Our operating system fundamentals are stronger from a software approach, which leads to better quality. Our sales teams will go out and say to operators, don't -- we want to spend your night and weekends with your kids and your partners because they spend a lot of time just reacting to as moves and changes or upgrades to the software that lead to instability. So all they care about is just running the network and making sure it doesn't go down. There's a lot of issues with vulnerabilities in like the Linux stack that forces upgrades. Upgrades are ripe for missteps, either manual configuration errors or you get a software regression. So in other words, something that used to work in your network was broken through that upgrade. And it was not uncommon in networking before Arista. So we're selling peace of mind, ability to sleep, take your weekends off and just run a better network. And the campus comes along with that or the routing piece. From an investment in your people, you just have to learn Arista EOS and CloudVision and then you can deploy in all these use cases rather than learning a different management stack for each piece.

So it's the cloud management.

Yes, it's around the -- kind of the integration of the whole stack across all those use cases.

And that's all integrated today. So you have pieces, but everything is integrated.

Everything is integrated today, right.

You mentioned part of the Chief Platform Officer is responsible for supply chain. The campus fees that you've been breaking out, I think, since '21. You had some supply chain issues in '22. Can you maybe just update us there?

Yes. So it wasn't unique to enterprise. I mean, it was kind of a generic all the supply chain challenges, but campus being the new piece in terms of just kind of hitting some of the revenue targets. The interest was there, but our ability to deliver was impacted by some of the supply chain shooters. And you're starting to see some of that catch up now.

Supplemental hierarchical view of back -- building backlog, we've seen and we'll get through it in terms of Cloud Titans maybe downtick in one of your large [ M&M ] customers. You took up guidance for '23 in terms of 30% growth, implying through the modeling, the enterprise would -- depending on where you were in terms of your models inflect into '23 in the second half maybe. Is some of that backlog related and just satisfying that backlog? Or is there some other element to the strength or even increased strength in enterprise here in '23?

No. The combination, I mean, we've kind of built up that strength going forward. We've seen larger deals, both in terms of customers that were already -- Arista customers just building out more as well as acquisition of new customers.

Okay. Let me just pause there for a second. Is there any questions in the audience or we switch over to cloud?

What you tell is the impact of the supply chain issues than [ bonds ] for comparisons is kind of waiting a little bit quite a lot that...

We were starting see availability of components, while the lead times of components are still very long, the predictability of delivery has been there the last 2 quarters. So when we order something, that comes in what it's supposed to, we're not seeing pushouts in terms of -- the lead times in semiconductors are still very long, I mean, close to a year. So the capacities improve, predictability has improved. But we're still probably seeing 2x the lead time at the component level than we saw pre-COVID.

So switching to cloud titans and that maybe just exploring not necessarily specifically, obviously, numbers in terms of the slowdown that was talked about on most recent calls for one of the -- one of your large cloud type customers that was really in -- that was really important for growth in '22 is driving growth. Would -- walk us through like the -- whether it be wallet share dynamics? Like why are they slowing? And I'm trying to get to the -- will this spend come back? And I'd like to just maybe even before we get to that answer, what drove -- because I think it would help answer that question, what drove that big uptick in spend of this customer in 2020?

Sure. I mean if we look back in 2019 at our business, we actually talked about customer waiting for next-generation server upgrades and kind of putting a pause. So going into 2020 with COVID, there was a little bit of a reaction to that pause as well as increased demand of these networks that really turned on the cloud business for us. So there's some smoothing effect there. And we still have tremendous growth in 2022 in the cloud business. So I think we're kind of getting back to a more probably normal cadence.

And again, just using that as a backdrop going forward into '23 and beyond trying to understand that sounds a little bit more cyclical. I'm trying to fare it out, is there -- was there a technological need at that particular customer that was looking to shift more dollars to say in Arista as they're building out i.e. whatever they're building out?

Yes. I mean we have good relations with all these cloud customers who have been multi-generational. There's a lot of integration and engineering -- the engineering work that we do Cloud Titans. And kind of looking forward, just in the cloud space, I think there was kind of some decision-making around what's going to happen with AI as a next-generation use case that people are starting to understand and digest when they start to look at 2024 and '25 and beyond.

Just trying to conclude that they're digesting some things that they both [ bought ] prior and then shifting focus to a different area.

Trying to understand that area that's pretty emerging, right? And I think a lot of focus is really how can AI help my business, how will the applications integrate? What's the value proposition around AI to my end customers. And so that's kind of going on at the top of the stack or maybe even at the business level. And then you have teams working on infrastructure, thinking about, okay, if this really comes to fruition, how many GPUs do I need? How do I deploy them? How do I deploy it at networking scale and thinking about how that can be more consistent to what they've typically done in the data center. So I would say in the last 6 months, this dynamic and discussion around how AI evolves has really taken front and center.

[ Can you talk about how cloud -- that AI addition was going on in the cloud as in general ]. How that's affecting the demand for higher speed? So you've got 400 now gigs and 800 -- what -- where were we at and -- so maybe, just talk about this [indiscernible]?

So just to kind of repeat the question for folks that are on the call. How does AI affect the speeds and the speed transitions and maybe how does it map in, if you will? So AI is definitely a bandwidth consumer and really wants to see low latency. You're spending a lot of money on GPUs and the endpoints and sit they're idle, like a factory sitting IO, you don't want to waste that. So there definitely is a propensity to the higher speed grades and a strong interest in 800-gig to move forward. So people are using 400-gig today in trial activity. There's also an interest in making the network better for AI and how you might enhance the Ethernet moving forward to either get better load balancing or better visibility into what's happening through the AI piece. So there's not a binary. It has to be 400 to 800, but it's definitely -- the people who are doing AI today are definitely wanting to use the highest performance available and definitely pushing towards 800-gig.

[indiscernible].

Yes. So the question is, is the industry ready on speed at the [ links ]? I think people would like 800-gig sooner, but 800 gigs in development today, and that's going to probably be the primary use case and driver to 800-gig.

[indiscernible]?

It's just work. I mean it's the whole ecosystem. It's the semiconductor chips. It's the optics. And I think a lot of that work was done for 400-gig. There were some new breakthroughs in coating schemes, et cetera. So I think that will follow its natural path, but it's just not there today.

I have heard about Ethernet consortium that you guys are a little bit on the better on the effort to NVIDIA [indiscernible]?

So maybe I'll back up as a of I talk about InfiniBand because I think it's on your list. This sounds like a good segue to the whole -- yes. So maybe I'll start with just some perspective on Ethernet versus InfiniBand. So InfiniBand was also developed by a consortium and the use case was high-performance computing. And InfiniBand has done some really good things. At the time, Ethernet was 1-gig, InfiniBand drove the technology for 10-gig that was later adopted by Ethernet. It also pushed 40-gig, which was adopted by Ethernet. At some point, these became more lockstep because the industry investment and the underlying technology is the same. So you now see 200-gig, 400-gig, 800-gig on both the InfiniBand and the Ethernet roadmap. The second thing that InfiniBand drove was a technology called RDMA to allow the applications to basically communicate without copying data is very efficient, well, Ethernet co-opted RDMA with a technology called RDMA over converged Ethernet, [ Rocky ]. So you see this kind of development of both. And actually, Ethernet today can be implemented in a lostless fashion with flow control similar to InfiniBand. But there are still differences, right, because of how they grew up. Ethernet, I think, has an opportunity as well as InfiniBand to improve for this AI workload, neither was built purpose-built for AI. So the consortium will look at things as actually improving the flow control mechanisms to make it more granular, to add visibility and to do some things around load balancing and other ideas that the consortium might bring to bear. I think it's -- the trajectory of Ethernet has been more of potentially competitors getting together to develop an open standard that can be adopted by many and people have liked that. It actually leads to competition and more investment with InfiniBand at this point being more captive with NVIDIA. So that's kind of the dynamic is a little bit around the consumption model today, right? But I don't think this is something unusual that Ethernet is doing just in reaction to InfiniBand. It's really the AI workload. And we see interest from the largest customers moving to Ethernet because of that multi-vendor component. They're interested in other GPUs. They might do be developing their own. So they're interested in the open ecosystem.

[indiscernible]?

I think pieces of technology can be adopted in a pre-standards mode. And I think typically, the Ethernet consortiums have gone to the Standards Committee for ratification. So it will be a combination of both. And it's -- I think a lot of people have the perception that Ethernet can't do AI today. That's not exactly true. I just can't do it as well as it will next year or the year after that.

I'd like to go back to this wallet share notion that maybe I'm not flushing out well, but the -- there was a reason why these providers, like you said, might have paused spending in 2019 for varied reasons, and then that was COVID. But there was a reason why architecturally when they build these road maps that are 5, 10 years long, they picked Arista. And there was a certain percentage of their spend that they were reporting to you, then this changes as we go forward. Collectively, the hyperscalers, especially in your customers are spending more into '24. So I want to know when you look at that road map, what does that look like for Arista relative to what you're discussing with them? Is it a notion of not specific to numbers, but I would love the technological reasons for why more wallet share spend from these guys when you sit down strategically with that or if you know what they're working on, not everything can go to GPUs?

Right. I mean I think Arista was fortunate to enter the hyperscale market before they were hyper. They were -- it was an underserved -- classic underserved market, and they were buying products designed for enterprise or service providers and redeploying them. A couple of them weren't happy with that, went and built their own technologies. And when Arista kind of emerged to focus on that market segment, Microsoft and Meta, in particular, were kind of poised to grow at the same time. And we've been able to develop that over multi-generations. They very concerned about operating networks with not as many people as users, millions and billions of users with a very small team relative. And that's still very much of a focus is simplicity of deployment, stability of the operating system, real block-and-tackle type of things. Now they've all diversified into more use cases, edge use cases, data center interconnect was something that was not on the original road map that we deployed. And then AI is probably the next new use case that we see coming to these data centers. And we'll have to adapt. We have to execute on those -- each one of these transitions or additional use cases is a little bit of an inflection, but I think we're well ahead of it.

Any questions from the audience? I don't know where this fits in terms of your responsibilities at the firm, but Arista has been -- there's a good percentage of share -- their revenue tied to service, software and services, and a good portion of that is software. I was just wondering if maybe you could comment in terms of that increased functionality and increased asks around this highly programmable opening cloud-based system at Arista? It could translate itself longer term despite more enterprise and cloud...

Definitely, yes.

In terms of ancillary software services.

No, great question. I mean, I think that we've seen in the cloud, you have customers that have the wherewithal to build their own management stacks and how they operate, also how they do network visibility, being able to collect a lot of data from the network and analyze it. Enterprise customers don't have the software teams to actually build that in-house. So we're filling that gap with CloudVision and implementing many of that capability that is typical in the cloud and CloudVision, and we've extended that CloudVision into other SaaS-based technologies. Our WiFi deployment is a cloud-based operating system, that's a ratable revenue model. We have now CloudVision as a service, which we host rather than have -- the customers have to deploy on-prem. So you start to see these kind of elements come into our enterprise mix. And I think you can expect that to continue.

And especially with the mix shift to enterprise...

Absolutely.

Going forward. Just if I may, I know we don't have either with who's retiring soon. But from a go-to-market perspective, just I think investors are always interested in terms of what's needed, and we can just even maybe start with [ listen ] go-to-market kind of motion for Arista to attack this gigantic TAM where they have relatively very low share in many aspects of enterprise network equipment and how it could impact the model?

Yes. I think a couple of things that we've done differently as folks have moved into the enterprise and challenge the incumbent. They typically come from a mid-market setting and then have a value proposition that is good enough. You don't need all the features and functionality. This is cheaper. It's 80% of the cost and actually all that complexity is something that you don't need. Our approach has been to actually go after the most sophisticated customers first and build downwards. So financial vertical, first, very challenging vertical and then build out from there and bring all the architectural pieces that you have to build in enterprise network. So the account teams get very focused on the Fortune 2000, how we can grow our wallet share in existing accounts, how we can penetrate some new accounts that have a high net worth spend. Then we have partners and resellers that come in to deploy those networks. Oftentimes, they're able to find other opportunities in adjacent regions that we probably wouldn't have gone after ourselves. And that's how we build out the go-to-market model. So there's always an opportunity to expand in a region. If we find a new opportunity and an anchor to start deploying a sales engineer and NSE to go after that and start to build out a region. So you'll see us do those kinds of things to build out the go-to-market.

But in the near term, just focusing on...

Focusing on that model. I think we get a lot of questions about the channel at some point in the future as we start to get satisfied with our share in sort of the Fortune 2000. I think that is an opportunity that would require more investment in the channel, but that's not here today.

One more time in of the audience, one more question? Well, thanks John very much for your time.

Thanks, Tom.

Thank you for...

Appreciate it. Thank you.