Arista Networks Q1 2022 Earnings Call Transcript

Quartr
Provided by Quartr
May 2, 2022

There are 24 speakers on the call.

Operator

Welcome to the Q1 2022 Arista Networks Financial Results Earnings Conference Call. During the call, all participants will be in a listen only mode. After the presentation, we will conduct a question and answer session. Instructions will be provided at that time. Conference is being recorded and will be available for replay from the Investor Relations section at the Arista website following this call.

Operator

Ms. Liz Stein, Arista's Director of Investor Relations, you may begin.

Speaker 1

Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me on today's call are Jayshree Yulal, Arista Networks' President and Chief Executive Officer and Ita Brennan, Arista's Chief Financial Officer. This afternoon, Arista Networks issued a press release announcing the results for its fiscal Q1 ending March 31, 2022. If you would like a copy of the release, you can access it online at our website.

Speaker 1

During the course of this conference call, Arista Networks Management will make forward looking statements, Including those relating to our financial outlook for the Q2 of the 2022 fiscal year, longer term financial outlook for 2022 and beyond, Our total addressable market and strategy for addressing these market opportunities the potential impact of COVID-nineteen, supply chain constraints, Component costs, manufacturing capacity, inventory purchases and inflationary pressures on our business, product innovation and the benefits of acquisitions, which are subject to the risks and uncertainties that we discuss in detail in our documentation filed with the SEC, specifically in our most recent Form 10 Q in Form 10 ks and which could cause actual results to differ materially from those anticipated by these statements. These forward looking statements apply as of today you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. Also, please note that certain financial measures we use on this call are expressed on a non GAAP basis and have been adjusted to exclude certain charges. We have provided reconciliations of these non GAAP financial measures to GAAP financial measures in our earnings press release.

Speaker 1

With that, I will turn the call over to Jayshree.

Speaker 2

Thank you, Liz. Thank you, everyone, for joining us this afternoon for our Q1 2022 earnings call. In addition to the pandemic, we are now facing the global uncertainty with the war in Ukraine and increasing inflation trends. On behalf of Arista, we express our deep concern over the tragedies in Ukraine and thank the Arista employees for their thoughtful donations to the Ukraine Humanitarian causes matched by the Arista Foundation. Back to Q1 2022.

Speaker 2

We delivered record revenues of 870 Renewals contributed approximately 19.2 percent of the revenue. Our non GAAP gross margins of 63.9% Was influenced by continuing supply chain constraints and elevated costs, vendor decommits for certain components increased sharply in March 2022 with no clear relief in sight in the near term. In terms of Q1 2022 verticals, Cloud titans was our strongest and largest vertical, followed by Enterprise, Cloud Specialty Providers and Financials tied at 3rd place and Service Providers at 4th. Our geographical mix included strong performance in the Americas at 76% with the international contribution at 24%. According to market analysts, in calendar 2021, Arista gained market share in overall data center High performance switching, growing to approximately 19% market share.

Speaker 2

We are proud to maintain our number one position in 100, 200 and 400 gig switching and achieve this growth despite all the challenges of the supply chain. Arista has also been a pioneer and leader in client to cloud networking. Our customer relevance is increasing with new logos in tech enterprises, healthcare, education and retail as well as the provider sector. Our $1,000,000 logos have doubled in the last 3 years in all categories. These categories include greater than 1,000,000, greater than 5,000,000, greater than 10,000,000 and greater than 25,000,000 customers.

Speaker 2

What's clear as I personally engage across the worldwide base of CIOs and CXOs is that the planning horizon for networking has really changed. Our visibility and demand has never been stronger. The nature of our discussions with our customers is also most strategic in nature. Let me try to illustrate with a few examples. For example, on AI Spine, we're building upon our cloud heritage to expand scale for AI workloads that are both data and compute intensive, thereby requiring 100, 400, 800 gig performance in the future with rich EOS software features.

Speaker 2

In the cognitive campus, threat hunting is now becoming integral to the network instead of being an afterthought And it's changing the way cybersecurity and vigilant threats can be detected and managed holistically. Network Security is clearly migrating to secure 0 trust networking based on AI and AVA sensors. In larger enterprises, Network as a Safe service based on cloud vision is enabling our customers to manage their datasets across client to cloud domains with superior unmatched automation and analytics. Our decade long preferred partnership with Cloud Titan, especially Microsoft and Neta, has helped forge joint engineering products for hypercloud scale All the way now to edge use cases. Clearly, Arista is in the midst of an exciting and growing total available market or TAM expansion, to fulfill our customers' quest for proactive, predictive and prescriptive networking.

Speaker 2

All this with the right Data Driven Foundation and Architecture. This network data lake EOS stack that we launched last November is resonating well and it's validating our customer network design. In conclusion, I'm so proud of Arista's progress and traction and look forward to multiple years of double digit growth. And with that, I'd like to turn it over to Ita for Q1 2022 financial specifics.

Speaker 3

Thanks, Jayshree, and good afternoon. This analysis of our Q1 results and our guidance for Q2 2022 is based on non GAAP and excludes all non cash stock based compensation impacts, certain acquisition related charges and other non recurring items. A full reconciliation of our selected GAAP to non GAAP results is provided in our earnings release. Total revenues in Q1 were 877,100,000 up 31.4% year over year and well above the upper end of our guidance of $840,000,000 to 860,000,000 Our Enterprise business continued to contribute healthily to our overall revenue growth in the Q1, combined with accelerated shipments to our cloud titan customers, some of which were deferred. Supply remained constrained in the quarter with supplier decommits resulting in higher broker purchases and expedite fees in the period.

Speaker 3

Services and subscription software contributed approximately 19.2 percent of revenue in the Q1, down from 21% in Q4. International revenues for the quarter came in at $212,700,000 or 24% of total revenue, down from an unusually high 29% in the Q4 of 2021. This decline in international mix primarily reflects some volatility with our global customers, including the deferral of some international cloud shipments in the period. Overall gross margin in Q1 was 63.9%, above the midpoint of our guidance range of approximately 63% to 64%. Operating expenses for the quarter were $225,300,000 25.7 percent of revenue, up from last quarter at $206,200,000 R and D spending came in at 144,300,000 16.5 percent of revenue, up from last quarter at $130,300,000 This primarily reflected increased headcount and higher new product introduction costs in the period.

Speaker 3

Sales and marketing expense was $66,200,000 or 7.5 percent of revenue compared to $61,200,000 last quarter, with increased headcount and strong shipments driving higher variable compensation expenses for the period. As a reminder, we continue to benefit from lower COVID related travel and marketing expenses. Our G and A costs came in at 14,800,000 or 1.7% of revenue consistent with last quarter. Our operating income for the quarter was $335,600,000 or 38.3 percent of revenue. Other income and expense for the quarter was a favorable $3,000,000 and our effective tax rate was approximately 20.7%.

Speaker 3

This resulted in net income for the quarter of $268,700,000 or 30.6 percent of revenue. Our diluted share number was 319,700,000 shares, resulting in a diluted earnings per share number for the quarter of $0.84 up approximately 35% from the prior year. Now turning to the balance sheet. Cash, cash equivalents and investments ended the quarter at approximately 3,400,000,000 We repurchased $136,200,000 of our common stock during the Q1 at an average price of $116 per share. As a reminder, we have now repurchased approximately $209,000,000 or 1,800,000 shares against our October 2021 The actual timing and amount of future repurchases is dependent on market and business conditions, business requirements, stock price, acquisition opportunities and other factors.

Speaker 3

Now turning to operating cash performance for the Q1. We generated $217,100,000 of cash from operations in the quarter, reflecting strong earnings performance combined with continued working capital investments. DSOs came in at 67 days, up from 58 days in Q4, reflecting the linearity of billings and growth in deferred revenue in the period. Inventory turns were consistent with last quarter, 1.7 times. Inventory increased to $694,200,000 in the quarter, up from $650,100,000 in the prior period, primarily reflecting higher component inventory.

Speaker 3

Our purchase commitment number for the quarter was $4,300,000,000 up from $2,800,000,000 in Q4. This significant increase in commitments largely represents orders for 2023 and beyond, reflecting overall strength and demand for those periods and our expectation that this long lead time supply environment continues. As a reminder, we continue to prioritize newer Our total deferred revenue balance was $1,100,000,000 up from $929,000,000 in Q4. The majority of the deferred revenue balance is services related and directly linked to the timing and term of service contracts, which can vary on a quarter by quarter basis. Approximately $327,000,000 of this balance, up from $160,000,000 last quarter, represents product deferred revenue, largely related to acceptance clauses for new products, most recently with our large cloud titan customers.

Speaker 3

As a reminder, We remain in a period of significant new product introductions combined with a healthy new customer acquisition rate and expanded use cases with existing customers. These trends have resulted in increased customer specific acceptance clauses and higher product deferred revenue amounts. Accounts payable days were 58 days, down from 63 days in Q4, reflecting the timing of inventory receipts and payments. Capital expenditures for the quarter were $14,900,000 Now turning to our outlook for the Q2 and beyond. Our Analyst Day outlook for 2022 calls for 30% year over year revenue growth, somewhat balanced across our market sectors and heavily constrained by the supply environment.

Speaker 3

As we progress through 2022, demand metrics remain strong across the business, with particular strength from our cloud titan, other cloud and enterprise customers. While we have added manufacturing capacity and component supply in response to this demand, Supplier decommits make forecasting accelerated shipment momentum difficult. These decommits also have a negative impact on gross margin as we must turn to other sources to try to backfill decommitted components in the quarter. From a business model perspective, this means that in this supply constrained environment, Any accelerated growth, while accretive to the bottom line, may come at a lower gross margin percentage due to increased cloud mix and additional expedite fees. Turning specifically to Q2.

Speaker 3

We expect revenues of approximately $950,000,000 to $1,000,000,000 including approximately $50,000,000 Cloud related deferred revenue recognition from the balance sheet. On the gross margin front, an expected healthy cloud mix in the quarter, combined with 200 to 300 basis points of assumed expedite costs, would result in gross margins of approximately 60% to 62%. As to spending and investments, we expect to continue to grow our investments in R and D and sales and marketing in line with our baseline investment plan. With all of this as a backdrop, our guidance for the Q2, which is based on non GAAP results and excludes any non cash stock based compensation impacts And other nonrecurring items is as follows: revenues of approximately $950,000,000,000 to $1,000,000,000 Gross margin of approximately 60% to 62% and operating margin of approximately 37% to 38%. Our effective tax rate is expected to be approximately 21%, which diluted shares on a post split basis of approximately 320,000,000 shares.

Speaker 3

I will now turn the call back to Liz. Liz?

Speaker 1

Thank you, Ita. We will now move to the Q and A portion of the Arista earnings call. To allow for greater participation, I'd like to request that everyone please limit themselves to a single question. Thank you for your understanding. Operator, take it away.

Operator

We will now begin the Q and A portion of the Arista earnings call. Your first question comes from the line of Sami Badri with Credit I

Speaker 4

have one clarification and then one question. First thing is, Ida, You talked about customer acceptance clauses. Can you just expand a little bit on that? Just because you do have some deferred revenue and it sounds like there's a lot moving around, could you just Define or maybe just elaborate a little bit more on that for specifically mid year 2022. And then my actual question is when we

Speaker 5

when you talk to your actual Suppliers, what do they actually tell you is the reason for

Speaker 4

the decommits? And when they do decommit, how many days before the actual planned delivery date

Speaker 3

Maybe I'll take the deferred revenue question first, right. I mean, obviously, in time periods where you have lots of New products, and you're bringing new products to these larger customers, in particular, to completely new customers. They don't have the opportunity to test Everything about the product in their environments and we can't mimic those large scale environments. So we have customer acceptances where we give them the So we can ship, bill and collect cash on those, but it's deferred from a revenue perspective Because there are some criteria that we need to prove that we satisfy, so that they can give us the acceptance.

Speaker 2

And Sami, to answer your question, the decommits come literally the week we are expecting the components. So they surprise us Right when we're looking to build them, which is why we struggled, frankly, in the back half of the quarter, not getting the components we needed And just having a lot of our contract manufacturing capacity waiting on key components And the only way to resolve that was to pay extra expedites by orders of magnitude to get them. Sometimes we could get them and sometimes we couldn't. So we believe this very constrained environment of components combined with decommit is going to continue in Q2. And who knows about Q3 yet?

Speaker 2

John McCool as our Head of Manufacturing and Platforms, do you have more to add to that?

Speaker 5

Sure. Just the nature of The decommits, I think that we see very part specific reasons for each of those decommits. Some can be tester Capacity, yield, logistics issues, as the suppliers work through that. So I wouldn't say there's any generic, means for those decommits. It really depends on what part and what supplier.

Speaker 4

Got it. Congratulations and thank you.

Speaker 2

Thanks, Sami. Thank you, Sami.

Operator

Your next question comes from the line of Fahad Najam with Loop Capital. Your line is now open.

Speaker 6

Thank you for taking my question. Jayshree, last time you said that you had the best visibility that you've ever seen. You pretty much said that you had Visibility for the entire calendar 2022. So I'm assuming you are already having conversations with your customers About that demand picture, maybe studying the calendar 23. So can you present a little bit of a color on the dynamics you're seeing with your customers regarding their Maybe calendar 42.

Speaker 6

Maybe if you can quantify what do you mean by the best visibility that you're having?

Speaker 2

Thank you, Fahad. Last quarter, our visibility was very strong for 2022. This quarter, our visibility continues to be very strong for 2023. But I would also add that in particular, the cloud titans and some enterprises are starting to plan for 2023. They have to start thinking about it now that we're in Q2 here.

Speaker 2

So all this to suggest that The demand is strong for this year. We expect demand to be strong at least for the first half of next year from a planning purposes. Things could always change. Orders could always be moved around. But in all my career across Cisco and perhaps even others, I've never seen demand be so clearly purposed and strong.

Speaker 2

Anshul, you want to add more to that?

Speaker 7

So Jayshree, I think customers are no longer struggling to understand that supply chain is constrained. They very well understand it. Many of these cloud companies build their own computer So they are planning along with their own teams for 2023 right now and their businesses are good, Which means the underlying demand is strong.

Speaker 6

If I could follow-up one on the deferred revenue from cloud, What was it? More just one cloud titan customer. Can you help us understand, is that a function of your cloud customer's ability to digest Your supply into them, anything you can help us understand on the dynamics and so we can model appropriately It's got tightened revenue times going forward.

Speaker 3

Yes. No, I think it's across multiple customers. And again, it's very standard for us if you look back Historically to have periods at the beginnings of product life cycles where we're shipping the product, they're deploying the product, But we're just waiting for that kind of acceptance so that we can actually take the revenue from a rev rec perspective, right? So it's not unusual for us To see this, you'd have seen that over time. What we said was we built deferred in Q1, and then we will draw down $50,000,000 in Q2, but we're still up roughly $110,000,000 for the first half from a product deferred revenue perspective.

Speaker 6

Appreciate the answer. Thank you.

Speaker 3

Thanks, sir.

Operator

Your next question comes from the line of David Voigt with UBS. Your line is now open.

Speaker 8

Great. Thanks guys for the question. Just a quick question and then a follow-up. So maybe just on the vendor Commits and what you're seeing from your CMs relative to 90 days ago, can you just

Speaker 3

kind of share with us

Speaker 8

a little bit more color in terms of what's been the impact? Is it The recent lockdowns that we've seen from supply chain partners in Asia or in other parts of the world Or is it just simply a reduction in availability and mismatched components that would make a complete set effectively? And then just quickly on a follow-up, you mentioned I think you had mentioned 200 to 300 basis points of expedited cost in the gross margin. Does that include sort of the mix shift to a more hyperscaler mix as well in the guidance for Q2? Or does that or

Speaker 5

is that just Separate costs in terms of

Speaker 8

how your gross margins are going to play out for the rest of the year? Thanks.

Speaker 3

Yes. I think the 200 to 300 basis points is really looking at Kind of an estimate, if you like, of what we think those decommits could cost us. So that's separate to the customer mix, etcetera. It's really been driven more By kind of looking at kind of the decommission that we saw end of last quarter, beginning of this quarter and then what's the impact for that, so it's separate to the customer mix.

Speaker 5

Yes. So I would say on the supply chain piece,

Speaker 4

I think we've kind of seen

Speaker 5

a more pointed or focused issue really around semiconductors in general that's So led by the supply demand at balance. And then in terms of particulars on decubets, I think again Each part, each device has a separate story. We've seen some suppliers that are trying to increase test capacity. They don't have test equipment. They're waiting for orders that are Also constrained by semiconductors, some perturbation with the lockdown to China for raw material and equipment.

Speaker 5

So it's across the board and very specific to each device.

Speaker 2

And I think it's safe to Just to clarify also that it's safe to also say it changed a lot since our last call. So we have a couple of vendors that are causing a lot of GAAP for our decommits. We don't want to name them because I know they're working hard to improve their commitment to us, but 2 or 3 vendors

Speaker 8

have completed Jayshree, was there any competitive issue in the decommits? Or that wasn't the issue, meaning Maybe there are some allocation issues between yourself and some of your competitors that does fall into the cycle?

Speaker 2

No, none that we're aware of.

Speaker 8

Great. Thank you. Thank you very much.

Speaker 2

Thank you, David.

Operator

Your next question comes from the line of Rod Hall with Goldman Sachs. Your line is now open.

Speaker 9

Yes. Hi. Thanks for the question. I guess I wanted to come back. First of all, thank you, Ita, for clarifying the deferred revenue In the guide, that's a helpful number.

Speaker 9

I'm just trying to come back. I was looking at your deferred revenue in aggregate over time. And obviously, it's very inflated here. Curious What you think the timeline for reducing that kind of back to some sort of a normal level is? I know it's very hard to predict, but just based on what you know today, is that Likely to happen this year, does it take 24 months, if you could gauge that for us.

Speaker 9

And then also, we don't really know what the backlog, the order backlog looks I don't know if you could quantify that at all for us. So kind of 2 different areas of question there, I guess. Thanks.

Speaker 3

Yes. I think on the deferred revenue, Like I said, I don't really like to forecast, but we will call out when we think we're drawing it down in the guidance. So that's the reference to the 50,000,000 I think at this point, I don't think we would draw it down to achieve a 30% growth rate. Obviously, this is churning and churning all the time, right? But we think that balance, it doesn't come down year over year I think on the order backlog, I'll let Jayshree comment as well.

Speaker 3

But for me, at this point, with the Impact of time, etcetera, on the backlog, it's not a meaningful number for us to share. It's not a meaningful metric to share. I don't know if you have any.

Speaker 2

Yes. No. Rod, we've stayed away from order strength and backlogs. We don't mean anything unless we can ship it. So we'll continue to keep telling you about our visibility and demand In a qualitative fashion, but in a quantitative fashion, the only number that matters is shipment.

Speaker 9

Okay, great. Thanks a lot. Appreciate it.

Operator

Your next question comes from the line of Amit Daryanani with Evercore. Your line is now open.

Speaker 10

Perfect. Thank you. I guess my question is really around, if I heard the purchase commitment number correctly, I think it was $4,300,000,000 is up a fair bit Sequentially. And I'm sure the math is not linear on purchase commitments, but could you maybe just help me connect the dot between a $4,300,000,000 purchase commitment versus what I think TTM cost of goods sold is around $1,200,000,000 Are you locking in supply on a multiyear basis? Or do you really see a sustainability of this current 30% growth to be a lot more durable versus perhaps what you talked about

Speaker 8

at the Analyst Day? Just let me Put in context,

Speaker 10

it seems like sizable number over here versus the growth rates.

Speaker 2

Yes, yes, yes. Amit, good observation. I think we jumped it from $2,800,000,000 to And you're absolutely right. This is a multiyear commitment now. This is not just for 2022, it's also for 2023 and perhaps it leads into 2024 as well.

Speaker 2

Given the extended lead times that are only getting worse, and we wanted to make sure we secured our commitments. So we're placing a bet on long term demand, Multiyear double digit growth and accordingly planning for it. And so you don't need to read any more Except we're bullish about demand and we're planning for multiple years.

Speaker 10

Perfect. Thank you.

Speaker 2

Thank you.

Operator

Your next question comes from the line of Simon Leopold with Raymond James. Your line is now open.

Speaker 11

Thanks for taking the question. I wanted to see if you could maybe describe what the timeline is like For your sales into a hyperscale data center, basically, what I'm trying to get a sense of is from the day they begin construction, How long does it take for them to make purchases from you in terms of initial deployment and then upgrade? So if you reflect back On your experience, how would you spread out the spending for a given hyperscale data center over a period of Number of years.

Speaker 2

Hopefully, that question makes sense. Yes, it actually does make sense because I think there's a period of planning and build out and what they want to do. Then there's actually putting a design on what they're going to do. And then there's the deployment. Anshul, you are still smack in the middle of this.

Speaker 2

This is yours to answer.

Speaker 7

Sure. Absolutely, Jayshree. When we work with our cloud titans, they think of regions and the build out in different regions, different geos It's sometimes different. You cannot actually just take a regional build out and say this will always be the same. In many of the major regions, which are 100 of megawatts or sometimes gigawatts, the DCI network needs to be built first Before racks can be added and some of the smaller or mid sized regions, they can actually start with racks and DCI can grow over time as well.

Speaker 7

But, net net, these are generally about 2 to 3 year planning cycles for the customer. And as equipment or supply is showing up, Last minute, they decide where they would deploy the network. So we don't really control the last part, but the planning is really 2 to 3 years.

Operator

Your next question comes from the line of Jason Ader William Blair, your line is now open.

Speaker 4

Yes, thank you. And I'm not going to ask a question about deferred revenue or supply. So, you'll be happy to hear that. My question is on the enterprise side, you guys continue to do well there. Wondering if Your ability to deliver supply faster than some of your competitors has made a difference.

Speaker 4

Maybe I don't even know that's true, but if you can comment on that. And also Whether subscription software mandates from some of your competitors is helping you win business and any examples of that would be great. Thank you.

Speaker 2

Yes. No, thank you, Jason, for sparing us the repeat question. If you step back and look at our enterprise momentum, I'd say It's really picked up steam in the last 3 years. In some cases, I think we're now larger than stand alone companies with our enterprise business who've been around 25 years. I think the reason the Enterprise business is growing so well is really three reasons

Speaker 3

and probably very little to do with the

Speaker 2

fact that we can supply products sooner.

Speaker 3

They all wish we could do

Speaker 2

it earlier. It has to do with an architectural approach that is different now, especially post COVID For our campus and data centers where they want to build off 1 EOS, 1 cloud vision and 1 leaf spine architecture. So they're really coming to us for a different design approach, Whereas historically, it was rinse and repeat. So that makes a huge difference. The second is their experience with us in the case of existing customers, Where they've had such good quality, lower critical vulnerabilities and experience with us that they really want to take that Across the network, client to cloud and many more use cases.

Speaker 2

And the third, I think, is what you alluded to. There is a lot of fatigue and frustration From our industry peers who've been going one way and only one way and seeing a better alternative both from a technology and consumption point of view, Well, we're not forcing them down a subscription and we're giving them options. They can have it as a service or they could buy it perpetually. It's the customer's choice. I think all of this has helped Really cement our enterprise momentum, at least with the high end enterprise adopters.

Speaker 2

We've got a long way to go in the mid market, But certainly, I would say that's the case for the enterprise high end customers.

Speaker 8

Thank you.

Speaker 3

Thanks, Jason.

Operator

Your next question comes from the line of Ittai Kidron with Oppenheimer. Your line is now open.

Speaker 12

Thanks. Good numbers. I guess a couple of 2 related questions. What's the value of purchase commitments in an age of decommits? And I guess, I'm trying to think about pricing and the impact on the gross margin, Ita going to or your guidance on gross margin.

Speaker 12

Why not move to a model, just an operating model, for the foreseeable future until things change, whereby Certain parts of your pricing are just variable and you price things to the customer as you get price yourself. Why not roll this over? And I know you can't do increases every quarter, but just have like an empty box on an invoice that gets filled in as you purchase components. And I don't think Clients would be overly surprised that something like this happens.

Speaker 2

Yes, we need to repeat you into our procurement department.

Speaker 3

I think my billing team might be a little confused.

Speaker 2

Good question, Itay.

Speaker 3

We want to start. Yes. So I think on the pricing side of things, Ittai, we'll start to benefit from the last price increase really kind of in Q4, really December, Maybe a little bit before that, but that's yes, that price increase is rolling through. Price increases are hard, right? I mean, we We'll look and consider when we see sustained costs, where we need to pass them on and we'll do that.

Speaker 3

But price increases are tough to do. They do kind of impact the customer. So we'll look and see if we need to do another one and how sustained some of these cost increases are and then we'll decide based on that.

Speaker 6

Very good.

Speaker 2

Thanks, Itari.

Operator

Your next question comes from the line of Meta Marshall with Morgan Stanley. Your line is now open.

Speaker 13

Great. Thanks. Sorry to bring it back to deferred revenue. But just a point of clarification, Ita. You had noted last quarter that the 30% kind of outlook for the year didn't include kind of recognition of any of that deferred revenue balance.

Speaker 13

But Obviously, the deferred revenue balance kind of grew by quite a bit. And so I just want to clarify that the 30% Is without kind of where we were at the beginning of the year on deferred revenue or even where we are now Or will be at the end of kind of Q2.

Speaker 3

Yes. I think Meta, the commentary around not drawing it down is really an annual statement year over year, Right. But what you saw us do for Q1 was obviously grow at $167,000,000 We'll draw down $50,000,000 of that. So I think the best way is to think about it as the first half, right? We'll be up $110,000,000 from our product deferred revenue at the end of Q2 based on our guidance, Right.

Speaker 3

So we're building it and I don't think we draw it down versus the beginning of the year at least and we'll see what happens in the second half. It's very hard to forecast it Precisely. But again, I think the 30% did not contemplate of taking anything out of the opening year deferred revenue balance at ParaMed.

Speaker 13

Okay. Got it. And then maybe just a small follow-up. I mean, obviously, the inventory balance has grown by a fair amount. Just wanted to get a sense of, are there any concerns around obsolescence of any of that inventory or Just as it takes longer to get all of the comp parts or is that not a concern we should be mindful of?

Speaker 3

Yes. I mean, I guess the inventory balance itself isn't That much, right? It's up a little bit on the raw materials, but not on a ton because obviously we're shipping everything we have that we can. I mean the purchase commitment balance is up a chunk, but I think again that's Time bound more than anything else, right? I mean, we're really looking through 2023 now and making commitments for that.

Speaker 3

And again, we're trying to Pick the right products. Well, that's certainly be perfect, but we're definitely taking a risk approach there, and we're doing it in conjunction with customers. So that's I think that's what we have to do right now.

Speaker 13

Great. Thanks.

Operator

Your next question comes from the line of Paul Silverstein with Cowen. Your line is now open. Thanks, guys. Steen with Cowen, your line is now open.

Speaker 14

Thanks, guys. At the risk of asking questions that you either cannot or will not answer, First off, I'm hoping Jayshree that you or Anshul or somebody could provide any incremental insight regarding the Microsoft Nokia announcement. And secondly, look at the numbers. Your first quarter results and second quarter guidance, that's almost 35% year over year growth. To do your 30% outstanding guidance for 'twenty two, that translates to about 26% growth for the second half of the year.

Speaker 14

And you're talking about the best demand environment you've ever seen. I appreciate we're only 1 quarter into the year. I get it, Well, it sure sounds like your supply permitting that you could do well north of 30%. I'm hoping you could provide some insight on that. And is the growth just going back or is it also showing?

Speaker 2

So to help you answer the Microsoft Partnership, you may have seen the quote in our earnings release. We consider Microsoft a very strategic and preferred partner and so do they of us. The use cases are expanding. And of course, that's like I've always said, doesn't mean we get 100% of the use cases or the business. They've always Multi vendor and open and from time to time they've chosen other partners for other use cases.

Speaker 2

So Doesn't change at all our status with them, but obviously means they're going to always be multi vendor and open. Anshul, you want to add to that?

Speaker 7

Sure, Paul. Our relationship with Microsoft is so long and so deep. We work with them not just for our current product, but for several generations to come. And the discussions on paper span all the way up to 2025, 2027 architectures and what can be possible, what we've built for them. So that leadership position we've had will continue.

Speaker 7

As Jayshree mentioned, they can be multi source, but we believe we'll stay in a healthy position And we're not going to get distracted by this announcement.

Speaker 2

Yes.

Speaker 3

And then Paul, I guess, coming back to the growth. I mean, yes, you're right. It was close to 35% for the first half. I think we would have an outlook of 30% for the second half. So I'm not necessarily saying we're going to decelerate off the 30%, But it's all about supply, right?

Speaker 3

If we could solve for these handful of components that are kind of causing these decommits, yes, we could do some more. But for now, I think we just have to respect that and the uncertainty of that and be cautious.

Speaker 14

Can I just ask a quick clarification? Jim, Matt, a lot of folks on the call, it sounds like people think you're just pulling out a deferred to make these numbers. How much of this is just satisfying backlog? How much of it is also shared in? What's going on in terms of driving the demand?

Speaker 3

I don't think that deferred I mean deferred is actually up $110,000,000 in our guide for the first half, right? So I don't think anybody thinks we're Using deferred to drive the numbers, right?

Speaker 2

We have organic demand, absolutely. We have backlog. We don't talk about that. And we have an increase

Operator

Your next question comes from the line of Samik Chatterjee with JPMorgan. Your line is now open.

Speaker 15

Yes. Hi. Thanks for taking my question. I guess, if I can just ask you 2 quick ones on the enterprise vertical here. Jayshree, you mentioned the momentum you have with enterprise customers.

Speaker 15

I mean, one of the concerns we've been hearing from investors is about the current macro and how enterprises respond to that But if you can just give us an update there. Thank you.

Speaker 2

Yes, Sami. We are seeing no change in the enterprise momentum. It's strong. We haven't seen any slowdown. Maybe it will later on.

Speaker 2

The impact of inflation trends, who knows. But at the moment, things are looking very strong. Krishmit, Ashwin and the whole team are just Knocking at the door always for products. They're certainly creating the demand with their customers. And as for the campus, very similar story.

Speaker 2

You know, our goal is Double this year, and we've only had 1 quarter, but 1 quarter doesn't make a trend, but this 1 quarter alone has is showing a trend in that direction. And as I think you asked me in the Analyst Day, I shared with you that we will grow at least to $750,000,000 by 2025. I think we can achieve that. Perhaps if we are in a less constrained environment, we could beat it too.

Speaker 15

Great. Thank you.

Speaker 2

Thank you.

Operator

Your next question comes from the line of Pierre Ferragu with New Street Research. Your line is now open.

Speaker 6

Hi, thanks for taking our question. Pierre is in a noisy environment. So this is Antoine asking one on behalf of the VTech team.

Speaker 8

So could you please share

Speaker 6

your thoughts on NVIDIA's Spectrum 4? How you see this chip fitting in the competitive landscape? And How you see NVIDIA possibly becoming a competitor? And maybe when do you expect to have 51.2 terabits per second chips in your products?

Speaker 2

Well, we've always viewed NVIDIA as a partner, especially for the DPUs and NICs when they were Mellanox, and we continue to view that. There are times when companies choose a vertical stack, and I think NVIDIA's focus on Spectrum 4 is more as a vertical Stack for their captive customer opportunities. As a horizontal best of breed, we don't see them as a competitor at all, and Arista is Poised to be best of breed and continues to be the preferred choice with customers. Anshul, you want to add to the 51 terabit roadmap?

Speaker 7

So, Pierre, let me just remind you that the 25.60 is just now ramping. So the world is very happy with that.

Speaker 2

Right.

Speaker 7

And The core development projects we take on with our customers are well along as well. But 51T is really next gen. It's at least 2 years out, maybe more for many of the high volume customers. And the announcement game doesn't really matter, right? Just because someone announced doesn't mean others are not working on the chip either.

Speaker 7

We will be ready in time.

Operator

And your next question comes from the line of Aaron Rakers with Wells Fargo. Your line is now open.

Speaker 16

Yes. Thanks for taking the question. A lot of my questions have been asked and answered. But I wanted to go back to kind of some of the architectural stuff That you've talked about, Jayshree, in the past. AI Fabric, you continue to bring this up on conference calls these last couple of quarters.

Speaker 16

We're seeing obviously some big large deployments at one of your large cloud titan customers. I'm just curious if you can offer up any other thoughts around The size of this incremental opportunity, the trajectory of what you're seeing, if you're seeing it become more broader based, just any context around that opportunity for Arista?

Speaker 2

Yes. Erin, I bring it up more because I think it's a strategic innovation much like, Arista pioneered cloud networking with the leaf spine architecture. And when it came to the forefront with a front end network that was based on their architecture, what we see here is that the back end network is changing. And that this used to primarily be interconnect, bus based, InfiniBand based and high performance Clusters, HPC as it's often called, but the new AI workloads really are data and compute intensive. And they can't be bus or IO based just focus on latency.

Speaker 2

They are pushing we're pushing the envelope of Ethernet to really deal with the predictable latency, the ability to scale a whole network, etcetera, very much in the first innings. So you're right to say it's starting with the early deployment of cloud customers, much like cloud itself started 5 years ago. But I think it's going to penetrate some of the specialty clouds and Workloads and large enterprises as well. But this will emerge and take place over the next 3 to 5 years. It's not going to happen overnight.

Operator

Your next question comes from the line of Tal Liani with Bank of America. Your line is now open.

Speaker 17

Hi, guys. I'm going to follow the tradition of one clarification and one question, the clarification. On one hand, you say supply chain is getting worse. On the other hand, you're getting you're giving a very strong guidance for next So how do you reconcile the fact that it's getting worse and the guidance is so strong? And the second question is one of the top questions I'm getting from investors is that we know that Microsoft and Facebook are strong.

Speaker 17

We know that they're investing a lot in their data centers right now. And the question is how much exposure, how much Dependency you have on this perhaps concentration customer concentration, vertical concentration, any data you can give on that front?

Speaker 2

Right. So, supply chain is getting worse because of the extended lead times, not just because of that, because we were planning for that, But because of the sudden surprising decommit. So when we're trying to build a product and ship it out and suddenly we don't have these last two components, It just freezes the whole supply chain and our ability to commit to revenue. So as it has said, what did we do at that point? John and the team had to go scouring the face of the earth To get parts that would normally cost X that are now 100X in many cases.

Speaker 2

And that's a very stressful thing because sometimes you get them and sometimes you don't. So our ability in Q1 to ship more was very much there, but a constraint in Q1 to ship more was also problematic because we couldn't get the parts. And that is the story for Q2 and perhaps we'll go into Q3 as well. Now how does that affect us? We may be executing better than others, But it's affecting us in that because of the elevated cost of these components and expedites, it's showing up as gross margin.

Speaker 2

So we have a gross margin pressure for the next couple of quarters, both due to the cloud mix, which was your second question, and the Commitments from Microsoft and Meta and other cloud titans as well as these expedites that are adding double pressure on our gross margin. So that's what we wanted to take away. We're going to execute as

Speaker 1

Do you want

Speaker 2

to answer the cloud question and especially with Microsoft and Meta Anshul?

Speaker 7

Sure. Well, these are 2 great customers to have And we wouldn't have it any other way. We don't control the market, right? These are some of the largest cloud companies in the world And we are the leader in cloud networking. So yes, we are exposed to them, but these investments are highly leveraged, Whether it's product development, whether it's developing the roadmap, whether it's getting economies of scale on a product line and manufacturing, there are several benefits we get and the customers get those benefits So as a result of that, we are happy that these customers are doing well and growing and yes, increasing their CapEx and we benefit from that as well.

Speaker 7

Jayshree mentioned this either the last earnings call or earlier, both of them are expected to be 10% customers this year. We are happy with that outcome.

Speaker 4

Got it. Thank you.

Speaker 2

Thank you,

Operator

comes from the line of Jim Suva with Citigroup. Your line is now open.

Speaker 11

Thank you and congratulations Jayshree and Ida to your Team, I have one question and that is about the lag time between your pricing actions and the orders. So Ida mentioned a few times about the December price increases. But I just wanted to see, wouldn't it be logical that All customers are putting in a lot more orders now to give you more visibility because selfishly or rightfully and smartfully and economically, To get better pricing knowing that prices are going to go up in the future or Ita and Jayshree are saying that you've adjusted prices Since that December price increase, I just wanted to get some color on the lab league of pricing orders. Thank you.

Speaker 2

Yes, Jim, thank you for the congratulations and wishes. So we made a pricing increase that we spoke to you about in November. The effectiveness of the pricing is very difficult to control right away. So first of all, we give them some notice. So historically, we have.

Speaker 2

And so orders in flight don't get affected by their pricing. Orders in backlog also don't get affected by the pricing. So all said and done, Even though we're getting new orders with the new pricing, everything that's shipping in Q1, Q2, Q3 and a good chunk of Q4 will have the old pricing. That's what we're trying to say. And but again, once again, if we make it now, its effect is not going to be until second half twenty twenty three.

Speaker 2

Does that help you answer the question?

Speaker 11

It does. And my point is, compared to November, things have really Changed. It's been 6, 7 months since now. So I guess it sounds like you're kind of contemplating, but I just was wondering if it was more dynamic since last November with your pricing.

Speaker 2

Yes. No, we've been very thoughtful about not shaking up pricing over and over again. Some of our competitors have done it 5 times. We've pretty much only done it once, But we are contemplating a second one.

Speaker 11

Got you. Thanks for the clarifications.

Speaker 2

Thanks, Jim.

Operator

Your next question comes from the line of Ben Bollin with Cleveland Research. Your line is now open.

Speaker 18

Thank you. Good afternoon, everyone. I appreciate you taking the question. Jay, Sherry and Ita, I was hoping you could touch on your thoughts Around the durability of the orders that you're seeing right now, Jayshree, you commented a little bit on hyperscale, but Any thoughts around how far in advance you're seeing orders from Cloud Titan and Enterprise customers? And then also, I'd be interested in your thoughts on the type of financial commitments you're seeing from the different verticals And how you're monitoring and managing the risk or perceived risk of excessive bookings or pull forward?

Speaker 18

That's it. Thank you.

Speaker 2

Okay. So you're asking about durability of our orders and authenticity of our orders, if I understood it correctly, right?

Speaker 8

Yes, I

Speaker 2

got it. First of all, Because we don't we fulfill 2 channels, but so much of our orders are very intimate relationships with our customers. To answer your second question first, We really believe the orders are not double booked or double orders. There may be some, but majority of our cloud orders, enterprise, cloud providers, service providers, these are Relationships, dialogues, conversations we have regularly. So we have no reason to believe at this point that there's double booking going on of any kind.

Speaker 2

There could be a minor percentage, but nothing major. In terms of durability, again, our customers are planning for a 1 to 2 year horizon. I believe the durability of our orders in this 1 to 2 year horizon is strong. Of course, there's always a risk that the orders are cancelable and they may make changes. But for most part, they've stayed committed to us, and we have seen them be consistent in wanting to get our product and willing to wait for it.

Speaker 2

So durability and authenticity is good.

Operator

Your next question comes from the line of Eric Suu Pajehr with JMP Securities. Your line is now open.

Speaker 19

Yes. Thanks for taking the question. One, just what are you telling your customers in terms of lead times for your longer lead time products? And how do what are your customers telling you in terms of how that compares to some of your competitors in terms of their lead times? And then, Ita, could you just comment the 200 to 300 basis point impact?

Speaker 19

Presumably, that's Q2 and Q3. Do you think that starts To dissipate after Q3? Yes.

Speaker 3

I mean, look, it's tough, right? I think we're probably with that At least Q2, Q3 and then we should start getting some relief from the pricing and other things in Q4. But I think I'd hold that through Q2 and Q3.

Speaker 2

Yes, Anand, lead times, it really varies by product and it varies by decommission right now. So we thought we were doing super well and we were king of the jambles on top of the line, If you asked us this last November, but I think things have degraded for all our peers and for us. So, 3 times are definitely measured in many weeks and many months.

Speaker 19

Do you strive to have shorter lead times than your competitors?

Speaker 2

We strive to execute better, and I think we have done better than our competitors, and we hope we continue to do so. What we don't do is promise one lead time and then come up with another, at least not intentionally.

Speaker 19

Let me ask this, do your competitor do you have customers leaving your competitors for you Noting that your lead times are shorter.

Speaker 2

They do try. I have had a number of enterprise customers Come to us and say, I got all of this I can give to you if you can ship now. But again, we're not able to ship now either. So Much as they try, the best we can do is face some kind of use cases for them in different products. But it isn't a case of direct substitution.

Speaker 2

It's a case of switching from one vendor to another and still having a plan across a period of time.

Speaker 1

Thanks, Eric. Let's go to the next question, please.

Operator

Your next question comes from the line of George Notter with Jefferies. Your line is now open.

Speaker 20

Hi, thanks a lot guys. I guess I had another question on purchase commitments. The 4,300,000,000 It's a big number, an impressive number. And certainly in this environment, it's very understandable. I guess if I play the other side of this, How do you see the risk of getting caught with lots of high cost componentry in the case where the supply chain ultimately corrects and prices normalize?

Speaker 20

Is that Something you guys think about, is it a risk in your mind or just simply worth it in terms of having more opportunity to gain share right now? Thanks.

Speaker 2

I think it's simply worth it, George. I've seen a few of these in my career. And the first thing you do here is you really procure your newest products, your components that are least likely to get obsolete, and I think we've been very smart and sensible about it. Second thing is, don't confuse purchase commitments with purchase arrivals. They've not arrived yet.

Speaker 2

They're going to take multiple Quarters or years to arrive, so think of this as a multiyear purchase commitment that could arrive in 2022, 2023 or in some cases 2024. And the third thing is we look at this as a wise investment for a lot of common components that will be in our new products as well. So all in all, no regrets. There may be some perturbation on some components that arrive and don't arrive, but Well, we feel good about this being one of our best investments for the short and long term.

Speaker 20

Got it. And is there any safety valve in that for you guys in terms of the ability to push out those deliveries or cancel orders? How do you think about that?

Speaker 2

Regarding push out, we'd rather they don't. We don't want that safety valve at the moment. So most of the orders in the industry, if you've been working around them, are generally non cancelable. But they can be managed from a time basis point of view.

Speaker 6

Thanks George. Thank you.

Speaker 2

Thanks George. Thank you.

Operator

Your next question comes from the line of James Fish with Piper Sandler. Your line is now open.

Speaker 21

Hey, thanks for squeezing me in here, given most of my questions have been answered, most of mine are just follow ups. I wanted to actually circle back to Suva's question on pricing, not Not so much on the magnitude of the price side, but what are you seeing with customers across your verticals of what you're implementing that can give confidence that you're not getting a pull in of orders of potentially more pass through being needed as these are smart buyers that can see the supply chain is likely getting worse if you're seeing it too. And then additionally, why not implement non cancelable terms like others in the space have? Thanks.

Speaker 2

Yes. No, I think they're both good questions, James. I'll take the first one. Non cancelable orders are easier said than done because they're based on contractual terms. So where we can do it, we will look at that, but generally speaking, we have long term contracts.

Speaker 2

And in terms of what was the other question? Pricing. Pricing and the impact of pricing or what was the question again?

Speaker 14

Yes. It was more on

Speaker 21

Not necessarily the actual pricing itself. We all kind of have heard it and know it, but it's more about what gives you confidence that we're not getting a pull in of orders

Speaker 2

Yes, yes. I had

Speaker 22

a potential guys taking the

Speaker 21

second step up. I

Speaker 2

mean, you

Speaker 4

have smart phones there.

Speaker 2

Yes. James, I think the key word is not pull in, but better planning. So they are obviously looking at their purchases. When the lead times are 6 weeks, they could look at This year, this year and not worry about next year. So but now they're having to consider their budgets and their plans for not only this year, but next year.

Speaker 2

So definitely, I think you're seeing the demand of not just this year, but as Anshul often likes to say, this year has an extra quarter, Maybe 2. So from that point of view, I think they are planning longer term.

Speaker 1

Thanks, James. Get the next question please.

Operator

Your next question comes from the line of Tom Blakey with KeyBanc Capital Markets. Your line is now open.

Speaker 22

Hi, Jayshree. Hi, Eta. Thank you

Speaker 5

for squeezing me here at

Speaker 22

the end here. A question is about software, so everybody can hang up and I'll just ask you guys this question. The business this business line, I saw a slowing of growth to 15% growth from 30 plus Last quarter, strong quarter, it could just be timing. But I'd love to just take the opportunity or to dive a little bit deeper in terms of what percentage of this line, it's important line in my mind, subscription, and ratable software, what percentage of services, maybe just take the opportunity to dive a little bit deeper in terms of what the largest Software solution, what the largest percentage of software solutions are?

Speaker 2

Tom, it's definitely work in progress. We could do better here. I would Automation licenses, analytics, etcetera. Then as you call them, the subscription revenue and as I've often alluded to, we don't just take our business and make it subscription. These are generally new businesses like Dans Monitoring Fabric for visibility, the AIVA sensors for threat hunting, CloudVision for network as a service.

Speaker 2

And they're doing well, but the revenue trails the bookings, as you know, they're multiyear subscriptions. And this is still small for us. And so these 2 buckets together can be viewed as something that's in the 10% range that we would like to double in the next few years, Right. And then there's the services bucket. When you do really well on product, the service percentages like you saw this quarter can get smaller.

Speaker 2

Q4 tends to be our strongest services and renewals bucket, and that tends to be typically in the Mid teens to sometimes high teens. So these 3 are really our recurring and software components, and they're very important, But they tend to dwarf when your product is terribly strong like it is this year.

Speaker 22

That's very helpful. And just one last Quick one to squeeze in here. On the deferred revenue delays that Ito referred to, you commented about new products causing delays. This has happened in the past and this is a Big uptick. Was there I thought I heard you say it was a new cloud customer.

Speaker 22

There's not many at Cloud titans. Was that accurate? Did I hear that right?

Speaker 3

No. So not in the cloud, it's really it's the it's Pretty much the existing customers, new use cases, new products. And then on the enterprise side, because there is some enterprise stuff in there too, it's new customers where we're deploying for the first time.

Speaker 1

Thanks, Matt. Thank you. We have time for one last question.

Operator

Your last question today comes from the line of Woo Jin Ho with Bloomberg Intelligence. Your line is now open.

Speaker 23

Great. Thanks for squeezing me in, guys. Just a clarification on the second half outlook. Is that dependent on the supply chain getting a little bit better from where it is right now? Or does that Assume that there's no changes to the de commit environment.

Speaker 23

Yes.

Speaker 2

I mean,

Speaker 3

I think, look, we're going to take this quarter by quarter here. I think our reference to the full year, etcetera, is assuming a continued constrained environment. I don't think we think the world changes that much, Right. But we'll take it quarter by quarter.

Speaker 8

Great. Thank you.

Speaker 1

Thank you. Thank you, Ajin. This concludes the Arista Networks' Q1 2022 earnings call. We have posted a presentation, which provides additional information on our results, which you can access on the Investors section of our website. Thank you for joining us today and thank you for your interest in Transdev.

Operator

Thank you for joining, ladies and gentlemen. This concludes today's call. You may now disconnect.

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Earnings Conference Call
Arista Networks Q1 2022
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