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

All right. Good morning, everyone. How's everyone doing? Thanks for coming so early. First session of the conference. It's always exciting. My name is Sebastien Naji from William Blair. I'm pleased to introduced Chantelle Breithaupt, CFO; and John McCool, Chief Platform Officer of Arista Networks. Before we begin, I am required to inform you that a complete list of research disclosures or potential conflicts of interest, are available on our website at williamblair.com. And with that out of the way, I think you have a presentation for us?

Yes, sure. Hi, good morning. Again, thank you for attending this very early session. We appreciate it. And thanks for giving us earliest time slot, Sebastien. So you'll just see the safe harbor statement here. And so these slides are to -- if you're new to Arista, to give you an overview, it would be 5, 6 minutes quick overview. And then for those that know Arista, a fresh reminder if there's anything here. This is typical IR deck material, so you can find a lot of these slides on our website. So Arista positioned to be a leader in data-driven networking. And what allows us that. We have, I would say, a sizable opportunity to us, and I know you're going to have questions or Sebastien have questions on that opportunity. Proud to have a very scalable architecture, single operating system, which is well received by our customers and allows us to expand through adjacencies. And then I think to -- we like to feel that we have a highly differentiated operating model that our customers enjoy and find easy to deploy and to realize their benefits. So very proud to have that in the company. Quick Arista at a glance, just over $6 billion. I think you know our gross margins around the 63%, 64%, high operating margin that we like to deliver to our shareholders. You'll notice on the top right, the IPO of 2014, we're happy to celebrate our 10-year anniversary tomorrow at the NYSE event in New York. So hopefully, we'll see some of you there, very excited for that celebration. Not an Analyst Day celebration. Joined the S&P 500 in 2018, proud to have over 9,000 customers across many different segments and verticals in industries and a leader in 100/400-gig. Updated chart in the sense of founders and leaders now running what we call Arista 2.0. So some familiar faces there, Jayshree, Andy, Ken, Hugh, myself joining 4 months in to the company. With me today is John McCool, Chief Platform Officer, long time Arista. And then the recent announcements of Ashwin Kohli and Chris Schmidt, to Chief Customer Officer and Chief Sales Officer, creating those roles for the company. Their rules are effective July 1, but they're already acting in the role day-to-day now and delivering to our customers and then General Counsel, Marc Taxay. So why do these 9,000-plus customers choose Arista? I think it's a fairly clear, concise, elegant model that we deliver to the customers. Hopefully, you agree delivering on innovation with the work of John, Andy, Hugh, Jayshree, et cetera, to ensure that we're innovative and keeping pace to being -- seeing around corners. Superior quality is one of our key fundamental kind of mantra for us. So in the sense that we ensure that there's quality before anything gets to the market and ensure that our customers experience that quality and then world-class support, getting great customer feedback in the sense of the way we support them. And outlook on our TAM. I think that you see since 2023 going from $37 billion to $60 billion. You can see the core adjacencies. Data center cloud is in the kind of that green, the adjacencies, campus and routing and then the cognitive network is the software and services portion. So $60 billion plus. Some ideas on the demographics of how we run the business and our results. You can see the upright I think, is probably the most interesting to you at this point is the market sector trends. So these are our thoughts in the sense of where these percentages would be over a length of time. So 40%, 45% for cloud AI, enterprise and financial and then the service provider in Tier 2 cloud. Fairly weighted from a U.S. Americas perspective, mostly driven by the Cloud Titan business. And then you can see the product trends to your left. And last but not least, we're proud after all the hard work of the 10 years since IPO, where we've kind of positioned ourselves as high-speed Ethernet market leadership, 100-gig, 200-gig and 400-gig. So I would like to kind of position this before we start our conversation. And with that, Sebastien?

Thank you. That's a very helpful overview. I guess maybe just a first question, somewhat of an easy one, but you're a recent addition here to Arista. You joined in February of this year. Maybe if you could give us after these first 4, 5 months, your perspective on what's really impressed you about Arista's culture, about Arista's organization and then where you think maybe there's room to improve or build upon the foundation?

Yes, sure, happy to. So I have -- I'm very excited to be Arista Networks. I was excited when I joined. But since I've been here 4 months, I'm even more excited to be at the company. I'll tell you why. A lot of my experience has been with larger companies, high matrix environments, lots of BUs, lots of different goals. But I really appreciate about Arista is everyone is clearly focused on the same goal, and that was the goal that you saw on the slide of being innovative, delivering quality and having world-class customer support. There's no confusion why the 400-plus employees come in every day and what goal they're looking for. A very elegant business model that serves across cloud, enterprise, et cetera. So really excited about the business model, Sebastian. I think it's very clear to see the goals and how to get there. The culture acts very much like a start-up with $95 billion market cap. I think the sense of everyone rolls up their sleeves, they're happy to do what needs to be done. Not a lot of egos that get in the way. And so I think that's refreshing and great. I don't know if I call them improvements rather than just the next steps that are needed. So if you think about where we are now, kind of the $6 billion to $7 billion range, I think that the next role is to how do we scale to $10 billion, $15 billion, what talent processes and investments are needed to take us to Arista 2.0. And I don't know improvements. I think it's just how do we do more of the same without clouding that elegant business model.

That makes a lot of sense. So you sort of laid out, you've got these 3 major segments that Arista serves the enterprise segment, the cloud titans and then the providers. I wanted to focus maybe the first question around the enterprise. That was one of the, I think, the unique takeaways from the last quarter is that despite most networking vendors seeing softness in the networking space and in demand, you guys are continuing to see strength there. Could you maybe highlight why it is that Arista is winning within the enterprise? And maybe give us a little color in terms of what do these enterprise wins really look like? Is it broad-based? Is it major large customers? Is it competitive wins?

Yes. No, great. I'll start, and then John, if you have anything, of course, to chime in. So I think from the -- so if you look back to our Q1 earnings that you're referring to, seeing strength in the enterprise. So overall, we're not the bellwether for enterprise, but we're certainly seeing the ability to gain share. And I think there are a few things that help us drive that. The first one is the sense of winning in the data center. So how do we take what we've learned in other markets and apply it to the data center. So that's one. But two is working on the whole portfolio. So we can go into the data center and win across the campus. We can go into the campus and then get to the data center. And I think that kind of horizontal play is what we're looking at and what we're working on from a technology perspective and a go-to-market perspective. And I think from the perspective of the kinds of customers, we're really focused on the financial -- sorry, the Fortune 1000, Fortune 500, Russell 2000. And so if you look at different segments and verticals such as banking, medical, health care, Feds led, so we're across very many different segments and verticals. So lots of opportunity there, Sebastien. And I think what's happening is we're demonstrating the quality, the value, the innovation consistently and our customers are seeing the ease of the operating model, their teams can be home on the weekend. It takes days versus weeks, weeks versus months. And I think we're just seeing that expand and getting reference customers, and that's expanding through their -- as they move, they take us to their new customers where they're working. So lots of different ways that we're working through that.

Anything to add John?

No, that's good.

And I think one of the comments that was made last quarter is that you're also seeing some activity from large maybe Juniper customers who are rethinking their Juniper deployment with this impending HPE, Juniper acquisition. Could you maybe talk about what you see as Arista's opportunity there? Are there any low-hanging fruit that you think will be some of those initial wins? Or what initial wins have you had?

Well, I think that -- so anecdotally from our customers at times, we're hearing, we're not sure of the road maps of some of the other choices they have as vendors. And so that road map, lack of clarity or lack of timing, I think, provides us an opportunity. So how we see that as we're invited to conversations. We're being asked to come in to take a look. We're having callbacks from people we spoke to 2 or 3 years ago. And so there's lots of different variety we're coming there. So how does it look? It looks in the sense of we take the call, we do the proof of concept, we come back and show them other similar industries where we've won our customers or peers of theirs. And so I think that it affords us the conversation and the low-hanging fruit is just when the call comes to take it and go in and show our product take the conversation from there. But there is lack of clarity in the customer base, I think, with some of these M&A activities going on.

That's helpful. And maybe turning to AI, which I'm sure everybody wants to talk about. I think maybe it would be helpful just to frame the AI opportunity for Arista. And the framework that I sort of used is there's 3 layers typically in your AI cluster, right? You have the interconnects that connect all the GPUs together into a server that scale up, then you have the back-end network that connects all these servers together, that's scale out. And then you have that front-end network that connects these AI clusters to the broader data center, the Internet applications, et cetera. I guess, across those 3 layers, can you maybe talk a little bit about what is Ethernet's opportunity? And then more specifically, what is Arista's opportunity to win each of those segments?

Yes. I'm going to clarify our 750 target and then John hand it over to you if that's okay, because I want to tie this. So we have stated in case you're not aware of the Arista's declaration that have, $750 million of AI revenue by 2025. And so that's kind of just by the back-end clusters in what you described, Sebastien, just to be clear, the $750 million because there's not a unified definition of what AI is across different companies reporting this number. And then, John, if you want to talk more...

Yes. So of those 3, today, we participate in the front-end network. So that's connecting the clusters into other aspects of the data center across the Ethernet. So that's here today. And I think that's uncontested for Ethernet. And in terms of the scale-up architectures, people are using -- talking about CXL, NVLink, other technologies for memory coherent architecture within the rack or the server itself. What's really interesting is the new network that comes in when you go scale out and you're connecting many GPUs today on the order of 30,000 GPUs. A InfiniBand has been positioned by NVIDIA as an option for connecting those GPUs. I kind of view that as a vertical integration of their stack. And that has challenges once you start to get beyond 1,000 connections. And you start to have to invent technologies that have already been well suited for Ethernet, the resiliency, the failover mechanisms, segmentation. We see the largest providers looking at going beyond 30,000 GPUs really driving the focus on Ethernet as the interconnect to the back end. And one of the reasons we're focused on the $750 million target is that's really a new opportunity and new TAM for interconnect that we haven't seen inside the data centers before.

Okay. That's helpful. I guess while we're on the topic of NVIDIA sort of the elephant in the room here. And to your point, they've -- they're very focused on NVLink and InfiniBand, but they've also talked about their SpectraMax, Ethernet class of solutions. In their latest earnings, they talked about that's going to be a multibillion dollar business within the next year. Can you maybe help us understand how does Arista differentiate from NVIDIA's own Ethernet solutions? And what are the advantages that you might have versus their ability to vertically integrate everything and sell it as a system rather than having to build those individual parts?

Yes, right. So a couple of pieces to that number, the spectrum number isn't just the Ethernet switching piece, but also includes the InfiniBand cable fiber interconnect, as well as the nicks that go into the server. So all of those are very important pieces of the solution. We obviously focus on the switching aspect of it. A couple of things, I think, that we're highly differentiated. Our ability to do the front-end networks interconnect routing and the other technologies, provide a solution that you can use for the front end or the back end of the network that's agile in both ways. Also being able to interconnect other types of devices. I think we've proven that we can interconnect pretty much anything in the data center, not just GPUs, not just NVIDIA GPUs. And as people are looking to source their own inference engines, or have diversity in their GPUs, that agnostic capability and being able to connect multiple things becomes highly important.

That's really helpful. I guess as I think about the $750 million target that you've laid out, I think one of the investor concerns is okay, maybe the switch ships are there, maybe the switches are there in terms of the speed but there's a whole ecosystem that needs to follow, whether that's NICs, whether that's optics. And that may be lagging a little bit and hurting the market of putting it together yourself versus buying that integrated solution. So maybe help us understand what are some of the gating factors right now that you see in terms of the rest of that Ethernet ecosystem being ready for prime time? And what is Arista's play or what is Arista doing to maybe help improve the overall ecosystems maturing?

Sure. I mean, it's not unlike any other transition we've seen. If you look at that ecosystem around 400-gig Ethernet today, it's there with optics and interconnect and NICs and the whole thing. The industry is moving to 800 gig, all the optics as well as the NICs as well the switches. And I think we're in a good position to take advantage of that opportunity.

And Sebastian, if I can also add to John's comments on. So that's one factor that could gain success or delay, right, in the sense of the ecosystem components and piece parts. The other 2 is if you look at the actual customer base, and I think you guys will know this as well as I do, but just to state it anyhow, is you have different company decision methodologies. And so you have some customers that are in the mode of build it and the ROI will come. Build it in the model will come. The payback will come. You have other customers that have board processes and financial processes that we want to see a demonstrated ROI. And so those customers might have a bit of a delay or a bit of a wait and see how other companies are rolling out their ROI and their business models for the sense of the payback on AI. So I think it really depends on how quickly companies feel they can lean in, which will gate how quickly. We're ready to serve when they're ready, we're ready to delight those customers but their internal processes on when they decide to go will be just as big of a gating factor, I think.

That makes a lot of sense. I think part of it is also the Ultra Ethernet Consortium which we've talked about before and having some of those standards ready like in the second half of this year, which will flow into product. Do you think when those standards are ready, is that sort of a catalyst or pivotal moment for the industry or are customers already working on these build-outs. And that will maybe accelerate a little bit, but it won't have a huge impact in terms of demand. What's your view on the impact of the Ultra Ethernet Consortium sort of things.

I'll give my view and then John can also probe that one. So I think it's -- customers aren't stopping or waiting for the UEC to come to fruition in the sense of having a standard. I think from our perspective, it won't be a binary event that once the standard is out, it's going to be a floodgate that opens. I think what it allows is some thoughtful design, some thoughtful choice in the sense of how to build that with a new product innovation to make the best decisions for the company and how to be smart about how to progress their deployments. But John, I don't know if you have anything.

Sure. Just to add to that, I think if you look back where we were our last Analyst Day, talking about AI, we saw an 800-gig opportunity. We also saw that both InfiniBand and Ethernet were not purpose-built for AI. And one of the things that Ethernet has done well as a community has evolved to incorporate new technologies and standards that could be interoperable. And one of the areas was around the transport mechanism, today's GPU interconnect, whether it be over InfiniBand or Ethernet is built on RoCE and RDMA. There's an opportunity for new transport mechanisms that go into the Linux stack to do a better job and do things around load balancing and really cater to this new environment of AI. So that's what the Ultra Ethernet Consortium is about and building in those new capabilities. But as Chantelle said, we haven't seen people slowdown in deployments of Ethernet today with the RoCE v2 capability that we've had for a long time.

Got it. Okay. And then maybe following this line of competition, I want to talk a little bit about Cisco. I think they will admit that they missed the boat on cloud 5, 7 years ago. And that allowed Arista to really take a pretty substantial amount of market share in the high-speed switching market. This time around, they've tried to get ahead of it. They say they're ready for AI. They have a very broad range of products. So maybe my question is, can you remind us why was that Arista was able to take so much share from Cisco during that cloud upgrade to 100G? And then what allows Cisco today to -- or what allow Arista today to maintain its market share and maybe even grow it as you go for this AI opportunity?

John, do you want to go...

Sure. I think Cisco did a good job in the '90s, figuring out how to connect everything to the Internet when that was all new. I look at where our 10-year anniversary is coming up this week of our IPO. We focused as a company on how operators would scale the Internet focused on those cloud companies with a single operating system, the ability to upgrade low security events, et cetera. And that scalability is what's appreciated today in the cloud as we go from 3,000 -- 30,000 GPUs to 100,000 GPUs, that same capability in the operating system to scale to be able to observe events, to fail over reliably, to be able to upgrade seamlessly without introducing new defects is going to be paramount. I do think there was probably a lack of focus on the 100-gig cycle. But when we went to 400-gig, we saw similar results, and we hope to do the same thing with 800-gig.

Great. Maybe turning to the financial model a little bit. I guess one of the questions that I get a lot and maybe just at the stage, there's been this dynamic within Arista where Cloud Titan gross margins tend to be lower than enterprise gross margins and so any mix shift usually has an impact on gross margin. I guess as Arista has more and more of a software stack they're able to sell, particularly within security, as you have this new AI opportunity that comes in, what do you -- what do you expect in terms of the gross margin dynamics here in this world of AI? Do you think there's room for upside to the gross margins from where they've been historically? And if not, why not?

Yes. I think that my view on that Sebastien to your question is margin always comes down to volume with the customer. And so I think there's a couple of dynamics here. One is, obviously, the Cloud Titans have leveraged due to the volume. So they're naturally going to be a different trajectory from a margin perspective. But even with the conversation on AI, you're going to have enterprise and AI Titans. So they're still going to remain a mix. So I'd say regardless of whether it's AI, cloud, software, there's always going to be a margin shift based on volume. So I think from that perspective, it will maintain in the sense that it will bounce around that's 62% to 65%, 64% range, depending on the mix. Always aim to do higher and better if we can. But it would be based on mix from that perspective. And I think from the software perspective, a lot of the features are on EOS now today, and it's not necessarily a separate software SKU, but delivering more functionality within that pricing model. So there's a lot of the go to market there, and I think we'll continue to afford us mix. But again, it comes down to volume of which customers are buying and which quarters or which fiscal years. Yes.

And to take away that sort of volume discount that happens. Is there a potential for a higher ASP related to an AI spine or an AI leaf versus a more traditional spine or leaf or not really?

Well, I think we're learning at the early stages. So I think that there's a lot of data points to go get before I could answer that question specifically. Yes, I think we're working with the same customers, so we would want to necessarily take advantage of the moments with our customers. So I think we have a balanced view going into that. And a lot of the products are not dissimilar, right? So it's not that you can have this 7,800 for data center cloud and this one is for AI. So therefore, we're going to charge you. So I think you have to be cognizant of the product can be the same product over different functionalities. So you have to be, I think, cognizant of that.

Just the one thing I would add, though, if you look at the 400-gig switch, it is driving the higher port speeds in terms of AI and the AI interconnect. So it is driving higher capacity switches in our portfolio.

And to that point, I think Jayshree has talked about this next upgrade cycle, 800-gig is going to be much faster than the 400-gig one was. What's driving that? Is it really AI demand? Or is there another component to that?

What we saw with the 400-gig cycle, it was really driven by the backbone upgrade. So if you take all the tiers of traffic and aggregate them, you need a higher capacity to upgrade the backbone. 800-gig cycle, if we waited for that cycle, probably we didn't push out, but 800-gig to the GPU is very real. And that use case is really bringing along the investments in 800-gig.

Got it. Okay. And then maybe last question, I think we'll open it up to a few audience questions. Is really -- for you, Chantelle. I just wanted to get an update in terms of your philosophy around capital allocation. I mean Arista has almost $5.5 billion of either short-term investments or cash on the balance sheet. What's your view on how that should be allocated, whether that's buybacks, whether that's potentially a dividend, whether that's M&A that's maybe more meaningful than it has been historically? Just love to get your thoughts there.

Yes, happy to. So I think the first one I would start with we're still at a size of the company relative to our competitors where we need to punch above our weight class. So we're always going to make sure that we have sufficient funds on the balance sheet for things that have happened in our past, and you can't predict, but there's always going to be something that comes up. So I think the one perspective is making sure we have pretty robust on hand given the size we have to make sure that we can handle the storm. The second one will be in the sense of organic investment. And I think this is where you're getting into maybe not M&A, but organic investment, that first box that you saw why 9,000 customers choose Arista for the innovation. So we'll make sure that we continue to fund innovation, and that could be sizable at times given new product introduction, et cetera. So that would be the second one or talent or processes in the sense of the other 2 items I talked about in scaling the company. The third one would be around buybacks. And so you've seen some of that happen since I've joined, and we'll continue to look at the right opportunity for buybacks. M&A, I go back to not necessarily looking to break what's working, and we have -- we think we have a pretty good thing going and we think there's a lot more we can do with that. So M&A would have to be very thoughtful and aligned to the strategy, aligned to the operating model to the elegance of EOS, et cetera. So M&A would have to be super thoughtful, but it's always something that's on the list, but not the highest end of the capital allocation versus the buybacks or the organic investment. Dividends, you -- dividends is an interesting conversation. I feel there's a time and place for dividends, and I don't think that's where Arista is at the moment. So that would probably not be at the top of the list for capital allocation at the moment. But there will be a right time in place for that, I think.

And then one more question for me just to take advantage of the fact that you're here John. Just around supply chain. I think one of the characteristics of AI hardware is that demand is ahead of supply and that takes me back to 2021, 2022, when we had all these supply chain issues in networking. I mean we've learned a lot since then. So maybe could you characterize you know what Arista is doing to help mitigate any sort of supply chain constraints it has currently or may have within the next year once a lot of these Ethernet systems are up and ready to ship.

Sure. Absolutely. So I think one of the things is lessons learned through the supply chain challenges that we had was every commodity matters, even the smallest commodity. So we have a lot more focus broadly across the supply chain in different elements. If you look back at the tail end of COVID, it was really the small chips and devices power logic chips that were used ubiquitously across multiple industries, especially consumer that were a challenge to get at. The tightness in the supply chain now is really around those large chips, which use an HBM technology that are used in GPUs and others. So we're keeping a thoughtful eye on that in terms of our purchase commitments and working with our suppliers as well as vigilance just around the global challenges in terms of risk and being able to mitigate those risks as we go forward.

Okay. Great. I think we have 2 minutes here. So maybe we'll take a few audience questions. You were first. And if you could repeat the question.

One thing that surprises me given how your growth over the last 10 years is that the international still a small [indiscernible], I wonder is that an opportunity or is that a problem?

Yes. So if you didn't hear the question, I think if I can summarize is. Hey, Arista, you've been around for a little bit now. Why are you still 80% Americas? So I think that there's a few things in there. So as we grow the denominator, hopefully, that becomes a smaller percentage. It is absolutely an opportunity to your question. So part of looking to scale the company is how do we do that rest of world. However, it's still a lot of the cloud Titan -- AI Titan business is Americas centered. So that's what keeps that kind of anchor weight to the Americas, but we're absolutely looking at Rest of World growth as we work through the next few years. Does that answer your question?

[indiscernible] it got to be an opportunity.

well, I said it's an opportunity.

Now you have one...

Go-to-market growth through the Arista 2.0 processes the organic investment that I mentioned the go-to-market, channel partners.

Great. Maybe time for one more question. Jason, go ahead.

John, does the Ethernet, InfiniBand battle remind you of the last -- competing over the last 20 years Ethernet sort of had various challenges so to speak...

Jason asking triggering question here about my longevity in the industry and other battles with Ethernet and InfiniBand. So absolutely, it reminds me of a lot of challenges, it reminds me of voice. So voice was on proprietary technologies, PBXs for a long time, and Ethernet rose for the challenge to build quality of service. And one thing I would tell people about Ethernet is not the technology. It's the competition around it, competitors coming together to agree on certain standards to make things better, even though we compete. And that's really been the bellwether and that's why I'm pretty confident InfiniBand's going to have a role, but I think Ethernet's going to have a bigger role. Thank you for that.

Great. Well, I think we're out of time. So we're going to have our breakout upstairs in Adler. Thank you for coming.

Thank you.