Arista Networks Q2 2023 Earnings Call Transcript

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Provided by Quartr
July 31, 2023

Key Takeaways

  • Arista beat Q2 expectations with revenues of $1.46 billion (up 38.7% YoY), non-GAAP EPS of $1.58, and a gross margin of 61.3%, and guides Q3 revenue of $1.45–1.50 billion with a ~62% gross margin.
  • One large cloud titan customer signaled a moderation in classic cloud CapEx as they shift spend toward AI, leading to near-term cloud networking demand softening.
  • The company is doubling down on AI networking—joining the Ultra Ethernet Consortium and rolling out EOS features like intelligent load balancing and microburst-detecting analyzers—with trials in 2023, pilots in 2024, and production-scale deployments expected in 2025.
  • Enterprise momentum remains strong, with multiple wins in data center, campus modernization, EVPN/VXLAN routing, and public sector networks, highlighting platform innovation, low TCO, and a unified EOS software stack.
  • CFO Ida Brennan, credited with delivering “pristine financials” over eight years, will retire in 2024, with succession planning underway.
AI Generated. May Contain Errors.
Earnings Conference Call
Arista Networks Q2 2023
00:00 / 00:00

Transcript Sections

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Operator

`Welcome to the second quarter 2023 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. If at any time during the conference you need to reach an operator, please press star followed by 0. As a reminder, this conference is being recorded and will be available for replay from the Investor Relations section at the Arista website following this call. Ms. Liz Stein, Arista's Director of Investor Relations, you may begin.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me on today's call are Jayshree Ullal, Arista Networks President and Chief Executive Officer, and Ita Brennan, Arista Networks' Chief Financial Officer. This afternoon, Arista Networks issued a press release announcing the results for its fiscal second quarter, ending June 30th, 2023. If you would like a copy of the release, you can access it online at our website.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

During the course of this conference call, Arista Networks management will make forward-looking statements, including those relating to our financial outlook for the third quarter of the 2023 fiscal year, longer-term financial outlooks for 2023 and beyond, our total addressable market and strategy for addressing these market opportunities, including AI, customer demand trends, supply chain constraints, component costs, manufacturing output, inventory management, and inflationary pressures on our business, lead times, product innovation, working capital optimization, and the benefits of acquisitions, which are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC. Specifically, in our most recent Form 10-Q and Form 10-K, which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

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

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Thank you, Liz. Happy last day in July, everyone. We delivered revenues of $1.46 billion for the quarter, with a non-GAAP earnings per share of $1.58. Services and software support renewals contributed approximately 15.2% of revenue. Our non-GAAP gross margins of 61.3% was influenced by improving supply chain overheads and higher enterprise contribution. We do expect gross margins to consistently improve every quarter this year and stabilize in 2024. International contribution registered at 21%, with the Americas at 79%. As we surpass 75 million cumulative cloud networking ports, we are experiencing three refresh cycles with our customers: 100Gb migration in the enterprises, 200Gb and 400Gb migration in the cloud, and 400Gb going to 800Gb for AI workloads.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

During the past couple of years, we have enjoyed significant increase in cloud CapEx to support our Cloud Titan customers for their ever-growing needs, tech refresh, and expanded offerings. Each customer brings a different business and mix of AI networking and classic cloud networking for their compute and storage clusters. One specific Cloud Titan customer has signaled a slowdown in CapEx from previously elevated levels. Therefore, we expect near-term Cloud Titan demand to moderate, with spend favoring their AI investments. We do project, however, that we will grow in excess of 30% annually versus our prior Analyst Day forecast of 25% in 2023. The AI opportunity is exciting. As our largest cloud customers review their classic cloud and AI networking plans, Arista is adapting to these changes, thereby doubling down on our investments in AI.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Arista is a proud founding member of the Ultra Ethernet Consortium that is on a mission to build open, multi-vendor AI networking at scale based on proven Ethernet and IP. There are a lot of software and EOS considerations for AI. AI traffic and performance demands are different as it comprises of a small number of synchronized high-bandwidth flows, making them prone to collisions that slow down the job completion time of AI clusters. As we connect thousands of GPUs, generating billions of parameters for petascale clusters, Arista's EOS capabilities must also scale along with our AI spine and leaf platforms to achieve that consistent performance and throughput. Arista has been developing EOS features such as intelligent load balancing and advanced analyzers to report and rebalance flows that can achieve predictable performance.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Customers can now pick and choose programmable packet header fields for better entropy and efficient load balancing of their AI workloads. Network visibility is also important in the training phase for large datasets to improve the accuracy of large language models. Arista's new AI Analyzer monitors and reports traffic counters at microsecond-level windows to detect and address microbursts. Our AI strategy and platforms are resonating well with our early customers. Presently, in 2023, we are in the middle of trials for backend AI networks, leading to pilots in 2024. We expect larger clusters and production deployments in 2025 and beyond. In the decade ahead, AI networking will become an extension of cloud networking to form a cohesive and seamless front-end and back-end network. In the non-cloud enterprise category, we continue to experience good momentum in both data center and campus.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Let me illustrate with a few customer wins. The first is an international new transportation win, where the customer was seeking to modernize their legacy campus. Their endpoints included large and small campus locations, internal communication devices, various IoTs, CCTV display boards, and much more. The customer mandated a fully automated workflow. Arista presented a highly optimized, best-of-class cognitive campus. With Arista's single binary EOS image across all campus platforms, complete with a universal API and built-in automation features, the customer was set on a path to continued campus modernization. The next enterprise win involves both data center and campus, with advanced EVPN, L3 VPN over VXLAN routing architectures instead of the traditional Layer 2 extension. Distributed AVA sensors were strategically positioned within the network to capture and analyze traffic at critical points.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

This zero-trust approach emphasizes threat mitigation throughout the network, as opposed to relying solely on siloed security. The integration of real-time streaming telemetry and visibility capabilities proved to be paramount in obtaining this operational acceptance. The final win was in a large public sector, connecting redundant data centers to hundreds of campus locations with a large routing environment. They were challenged with complex MPLS routing that was hard to operate across the WAN and campus network. An upgrade of any magnitude implied several million dollars, impacting change controls to touch on all their sites. Arista demonstrated that the customer could use a single spine for both LAN and WAN to dramatically simplify and automate the whole environment within 30 days. This 80% reduction in total cost of ownership was made possible with Arista's modern cloud operating model.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

You can see a recurring theme here across all these customer wins, which is the power of our platform innovation, quality, and support with a low TCO and a single CloudVision and EOS software stack. Arista is diversifying its business to transform the enterprise to a modern network operating model. Before I hand to Ita, I would like to share with you that Ita is planning to retire sometime next year in 2024. She has had a stellar career at Arista as our Chief Financial Officer. Ita has been our business partner and friend for the past 8 years. She has displayed the Arista way, always prioritizing our customers, employees, and shareholders. Ita has demonstrated and delivered both growth and profitability with a very, very small G&A investment, often only 1.5% of revenue.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

These type of pristine financials are so rare in a fast-growing tech company and only possible with a shared vision between the CFO and CEO. Ita, thank you for your steady leadership and contributions. Undoubtedly, we will miss you next year when you retire. Over to you for financial metrics.

Ita Brennan
Ita Brennan
CFO at Arista Networks

Thanks, Jayshree. That's very kind. It's been an amazing experience working with you and the whole Arista team over the last eight years. Now, back to the numbers. This analysis of our Q2 results and our guidance for Q3 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 Q2 were $1.46 billion, up 38.7% year-over-year, and well above the upper end of our guidance of $1.35 billion-$1.4 billion. Services and subscription software contributed approximately 15.2% of revenue in the quarter, up from 14.9% in Q1.

Ita Brennan
Ita Brennan
CFO at Arista Networks

International revenues for the quarter came in at $304.4 million, or 20.9% of total revenue, up from 17.5% last quarter. This quarter-over-quarter increase largely reflected a healthy contribution from our enterprise customers in EMEA and APAC, and some reduction in domestic shipments to our Cloud Titan customers, which were unusually robust in the prior quarter. Overall gross margin in Q2 was 61.3%, in line with our guidance of approximately 61% and up from 60.3% last quarter. We continue to see incremental improvements in gross margin quarter-over-quarter, with higher enterprise shipments and better supply chain costs, somewhat offset by the need for some additional inventory reserve as customers refine their forecasted product mix.

Ita Brennan
Ita Brennan
CFO at Arista Networks

OpEx for the quarter were $287.3 million, or 19.7% of revenue, up from last quarter at $257.5 million. R&D spending came in at $188.5 million, or 12.9% of revenue, up from $164.8 million last quarter. This primarily reflected increased headcount and higher new product introduction costs in the period. Sales and marketing expense was $79.6 million, or 5.5% of revenue, compared to $75.9 million last quarter, with increased headcount and product demo costs. Our G&A costs came in at $19.1 million, or 1.3% of revenue, consistent with last quarter. Our operating income for the quarter was $606.5 million, or 41.6% of revenue.

Ita Brennan
Ita Brennan
CFO at Arista Networks

Other income and expense for the quarter was a favorable $31.6 million. Our effective tax rate was 21.4%. This resulted in net income for the quarter of $501.2 million, or 34.4% of revenue. Our diluted share number was 316.5 million shares, resulting in a diluted earnings per share number for the quarter of $1.58, up 46% from the prior year. Turning to the balance sheet. Cash, cash equivalents, and investments ended the quarter at approximately $3.7 billion. In the quarter, we repurchased $30 million of our common stock at an average price of $137.2 per share.

Ita Brennan
Ita Brennan
CFO at Arista Networks

We've now repurchased $855.5 million, or 8 million shares, at an average price of $107 per share under our current $1 billion board authorization. This leaves $145 million available for repurchase in future quarters. The actual timing and amount of future repurchases will be dependent on market and business conditions, stock price, and other factors. Now turning to operating cash performance for the second quarter. We generated approximately $434.1 million of cash from operations in the period, reflecting strong earnings performance, partially offset by ongoing investments in working capital. DSO came in at 49 days, down from 57 days in Q1, reflecting a strong collections quarter with good linearity of billing. Inventory turns were 1.2x, down from 1.3 last quarter.

Ita Brennan
Ita Brennan
CFO at Arista Networks

Inventory increased to $1.9 billion in the quarter, up from $1.7 billion in the prior period, reflecting the receipt of components from our purchase commitments and an increase in switch-related finished goods. Our purchase commitments at the end of the quarter were $2.2 billion, down from $2.9 billion at the end of Q1. We expect this number to continue to decline in future quarters as component lead times improve and we work to optimize our supply positions. Our total deferred revenue balance was $1.085 billion, down from $1.092 billion in Q1. The majority of the deferred revenue balance is services and related and directly linked to the timing and term of service contracts, which can vary on a quarter-by-quarter basis. Our product deferred revenue balance declined approximately $33 million from last quarter.

Ita Brennan
Ita Brennan
CFO at Arista Networks

Accounts payable days was 57 days, up from 55 days in Q1, reflecting the timing of inventory receipts and payments. Capital expenditures for the quarter were $11.6 million. Now turning to our outlook for the third quarter and beyond. To recap, global supply chain disruptions over the last couple of years necessitated elongated planning horizons and customer demand signals. The corollary is also true. Improving lead times are now driving shorter planning horizons and demand signals, delaying when customers need to place new orders. This is particularly true of our Cloud Titan customers, who, following a 1 year of elevated purchases, must now grapple with changing technology roadmaps and priorities before providing visibility to future demand later in the year.

Ita Brennan
Ita Brennan
CFO at Arista Networks

On the supply side, we expect to continue to ship against previously committed deployment plans for some time, targeting supply improvements where most needed, but also careful not to create redundant customer inventory. In spite of the return to shorter lead times and reduced visibility, we are executing well, with gradual incremental improvements to our 2023 outlook, which now calls for year-over-year growth in excess of 30%. On the gross margin front, we expect continued progress through the end of the year, reflecting supply chain and manufacturing benefits while maintaining a reasonably healthy cloud contribution. Turning to spending and investments. We continue to monitor the overall macro environment carefully. We'll prioritize our investments as we move through the year. This will include a focus on targeted hires in R&D and go-to-market as the team sees the opportunity to add talent.

Ita Brennan
Ita Brennan
CFO at Arista Networks

On the cash front, while we'll continue to focus on supply chain and working capital optimization, you should expect some continued growth in inventory through the end of the year. As a reminder, our 2023 tax payments have been deferred to October and will represent a significant use of cash in that quarter. With all of this as a backdrop, our guidance for the third quarter, based on non-GAAP results and excludes any non-cash stock-based compensation impacts and other non-recurring items, is as follows: revenues of approximately $1.45 billion-$1.5 billion, gross margin of approximately 62%, operating margin at approximately 41%. Our effective tax rate is expected to be approximately 21.5%, with diluted shares of approximately 318 million shares. I will now turn the call back to Liz.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Thank you, Ita. We will now move to the Q&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

Thank you. We will now begin the Q&A portion of the Arista earnings call. In order to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, it is star one again. We ask that you pick up your handset before asking questions in order to ensure optimal sound quality. Your first question comes from the line of Michael Ng with Goldman Sachs.

Michael Ng
Michael Ng
Analyst at Goldman Sachs

Hey, this is Mike ng from Goldman Sachs. Thanks for the question. I was just wondering if you could talk a little bit more about the outlook for in excess of 30% year-over-year growth this year on revenue. You know, what's gotten better relative to last earnings call? If you could talk about it in the context of, you know, Cloud Titans versus Enterprise, that'd be helpful. I'm just trying to reconcile the revenue upgrade versus the commentary about, you know, near-term Cloud Titan growth moderating. Thank you.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Yeah. Thanks, Mike. I think, it's, it's pretty clear that from quarter-over-quarter, our enterprise momentum continues to get stronger and better, and our cloud is strong. However, it's got two components now. There's the classic cloud networking and then the AI. We're reconciling how we double down more on AI, which we are feeling stronger and stronger about. Even on the cloud, you know that the last 2 years have just been out of this world and phenomenal. While it's moderating, it's still pretty good.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Thanks, Mike.

Michael Ng
Michael Ng
Analyst at Goldman Sachs

Thanks, Jayshree.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Session.

Operator

We'll take our next question from Tim Long with Barclays.

Tim Long
Tim Long
Senior Equity Research Analyst at Barclays

Thank you. Jayshree, I was hoping you could dig more into some of the comments around AI. Sounds like there's, you know, a large pipeline there, and you talked about kind of the stages with 2025 being the big growth area. I'm curious if you can just talk a little bit about a few things related to that. One, do you see that the move to AI expanding or diversifying more your Cloud Titan or your cloud customers? Second, can you talk about kind of the next year or two, the, the entire, you know, the InfiniBand versus Ethernet debate? I think you guys have been trialing some Ethernet inside clusters.

Tim Long
Tim Long
Senior Equity Research Analyst at Barclays

Can you just give us an update on how you think that, you know, competition between those two technologies, how you think that's gonna play out? Thank you.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Okay, thank you, Tim. Maybe my answer will be shorter than your question. I think the gist of what I'd like to first of all say is, majority of Arista's participation has been in the front end of the network, right? We're getting a chance for the first time ever to play in the back end. When we think AI, there's clearly some ramifications of bandwidth on the front end of the network, but we're not counting that. We're truly thinking of something that's incremental, brand new, lot of work to do in testing, proving, pilots, trials, before we get into production. today, I would say in the back end of the network, there are basically three classes of networks.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

One is very, very small networks that are within a server, where customers use PCIe, CXL, there's, you know, proprietary NVIDIA-specific technologies like NVLink, that Arista does not participate. There's more medium clusters. You can think generative AI, more for inference, where they may well get built on Ethernet. For the extremely large clusters, you know, with large language training models, especially with the advent of ChatGPT 3 and 4, you're not talking about not just billion parameters, but an aggregate of trillion parameters. This is where Ethernet will shine. Today, the only technology that is available to customers is InfiniBand. Obviously, InfiniBand, with 10, 15 years of familiarity in an HPC environment, is often being bundled with the GPUs.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

The right long-term technology is Ethernet, which is why I'm so proud of what the Ultra Ethernet Consortium and a number of vendors are doing to make that happen. Near term, there's gonna be a lot of InfiniBand, and Arista will be watching that outside in, but longer term, Arista will be participating in an Ethernet AI network. You know, neither technology, I want to say, were perfectly designed for AI. InfiniBand was more focused on HPC, and Ethernet was more focused on general purpose networking. I think the work we are doing with the UEC to improve Ethernet for AI is very important.

Tim Long
Tim Long
Senior Equity Research Analyst at Barclays

Okay, thank you. That's very helpful.

Operator

We'll take our next question from Meta Marshall with Morgan Stanley.

Meta Marshall
Meta Marshall
Analyst at Morgan Stanley

Great, thanks. Just revisiting kind of the Cloud Titan commentary. You know, does the change that you're seeing mean that they're completing kind of one upgrade cycle, there might just be time between the next upgrade cycle, or are there real changes to kind of current deployment plans, or kind of deployments of the current upgrades? Thanks.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Yes. Sorry,

Meta Marshall
Meta Marshall
Analyst at Morgan Stanley

Sorry, Mita, were you addressing the question to Ita?

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

I think.

Meta Marshall
Meta Marshall
Analyst at Morgan Stanley

I guess I was addressing to whoever wants to answer about the kind of commentary on the changes in the Cloud Titan order.

Meta Marshall
Meta Marshall
Analyst at Morgan Stanley

Go for it, Anshul.

Anshul Sadana
Anshul Sadana
COO at Arista Networks

Sure, Meta, you know, when you look at the cloud customers, in the last few quarters, especially since the advent of ChatGPT, there's been a rotation in the AI. It's not that they're done with the upgrades or there's a score on the upgrades, but they had to reprioritize their business and their deployments for AI. You've seen the competitive battle between the largest of the largest titans in the world trying to get ahead. We see signs of that thawing, and in the future, we believe they'll be back to adding and refreshing the standard computer infrastructure as well.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

You know, I always like to. You can only do so for so long. Eventually, you have to eat. I think we will see a nice mix of AI and classic cloud networking over time.

Meta Marshall
Meta Marshall
Analyst at Morgan Stanley

Yeah, I think the, the, the lead time improvements have kind of facilitated, you know, them waiting, for a little bit longer than what we've gotten used to over the last couple of years. I think again, that's kind of we're going to start coming within lead time here pretty soon, then we'll see. Yeah.

Meta Marshall
Meta Marshall
Analyst at Morgan Stanley

Thank you.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Thanks, Mita.

Operator

We'll take our next question from Ben Bollin with Cleveland Research.

Ben Bollin
Analyst at Cleveland Research Company

Good evening, everyone. Thanks for taking the question. Ita, congrats. I had a question for you. I was hoping you could speak to where you see lead times presently. You talked about, you know, taking a little bit more managed approach to inventory levels at customers. Could you talk about some strategies that you employ to manage that and where you might see, where you think inventory levels are within those accounts? Thank you.

Ita Brennan
Ita Brennan
CFO at Arista Networks

Yeah, I think, look, the lead times are, you know, mixed across products. I mean, our goal certainly is to try to get back to, like, a six-month lead time here. You know, maybe the end of the year, certainly early next year. But it is currently mixed across products. You know, the commentary around customer inventory and stuff, we, we've been very diligent all the way through this process, the supply chain process, of trying to make sure we understood, demand when it showed up, and that it was being put into reasonable deployment schedules and deployment plans. We just want to continue to do that as we come through the other side of, of really that whole supply chain disruption.

Ita Brennan
Ita Brennan
CFO at Arista Networks

It's really more, you know, understanding kind of, you know, what customers need, when they need it, and again, being able to prioritize and, and make sure that we understand that. It's really a continuation of what we were doing, honestly, on the other side of the supply chain, when you had these... You know, we had this kind of, accelerated demand, and then we were very focused on deployment schedules and timing. This is just the other side of that. Again, making sure we understand what's happening.

Ben Bollin
Analyst at Cleveland Research Company

Thank you.

Operator

We'll take our next question from Antoine Grignon with New Street Research.

Antoine Grignon
Antoine Grignon
Analyst at New Street Research

Hi, thanks a lot for taking my, my question. This is maybe a bit of a, of a longer-term question, but can you please provide an update on, on the opportunity at hyperscalers beyond your two largest customers? Does the accelerated deployment of AI clusters potentially open the door to business with the other two hyperscalers, as the complexity of the networks is increasing rapidly?

Anshul Sadana
Anshul Sadana
COO at Arista Networks

You know, this gets asked very often, how we're doing with them, and we continue to do well with them. As I mentioned before, not all titans are the same in terms of size. Some are small, and we do very well with them, but they're just not as big as our two largest customers. Others who have the potential, we're still doing very well technologically with them, but we haven't seen the opportunity materialize. It's not that we're losing to anybody, it's just nothing has changed, and we continue to invest with them, and we believe the opportunity is still ahead of us.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

I, I exactly, Anshul. I think the way to look at our AI opportunity is it's, there's 10 years ahead of us. We'll have early customers in the cloud with very large data sets, you know, trialing our Ethernet now. Then we will have more cloud customers, not only cloud titans, but other high-end tier 2 cloud providers and enterprises with large data sets that would also trial us over time. In 2025, I expect to have a large list of customers, of which cloud titans will still end up being some of the biggest, but not the only ones.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Thanks, Antoine.

Operator

Our next question comes from Amit Daryanani with Evercore.

Amit Daryanani
Amit Daryanani
Senior Managing Director at Evercore ISI

Oh. Yep, thanks, and congrats on a nice quarter here. You know, I guess my question is really, you know, there's been a fair bit of debate among investors on what does calendar 2024 look like for Arista, and the fear, I think, always is it could look like calendar 2020 when you have some cloud digestion. I realize it's really early for you to guide 2024, but if you just sort of think about the puts and takes into next year, that would be helpful. Maybe, Jessie, you could talk about how do you think Arista is different today versus in the calendar 2019, calendar 2020 time frame? That would be helpful.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Yeah, no, that's a really good question. Stay tuned for our 2024 guide when we have our Analyst Day sometime in November. Qualitatively speaking, we're a very different company today than 3 years ago. Clearly, we've doubled down on our Cloud Titans, and you, you know that they're getting stronger and stronger. Even in the Cloud Titans, you know, Anshul and the team have worked to have a number of use cases. It isn't just one. The addition of AI to that use cases just gave us a whole other broad opportunity from front end to back end, right? To me, the holistic and seamless and cohesion between the front end and back end will get even more important as time goes on in Cloud Titans.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

We also see that we're stronger in tier two providers and of course, the broader enterprise. Both of these were not as strong for us two years ago, and they also represent AI opportunities, but as you know, they represent campus, routing, classical data center opportunities, and, and allow us to go target a much larger TAM. Again, three years ago, it was probably $30 billion. Three years later, it's well north of $50 billion. I feel we are much more diversified, and while we deeply appreciate M&M, we got a lot more candy beyond that.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Thank you, Amit.

Amit Daryanani
Amit Daryanani
Senior Managing Director at Evercore ISI

Perfect. Thank you.

Operator

We'll take our next question from Tal Liani with Bank of America.

Tal Liani
Tal Liani
Managing Director and Senior Research Analyst at Bank of America

Hi, Ita. I have to ask you a tough one before you go, so you have a good taste for the rest, few years. How much of the growth this time is coming from backlog drawdown? Can you give us some information about the order trends rather than revenues? The reason why I'm asking it is because your guidance for 3Q is 25% growth. When I look at 4Q, it's the implied is 11%, so there is a sharp deceleration in growth in 4Q, and I'm wondering if it's a function of backlog and of elevated backlog. Thanks.

Ita Brennan
Ita Brennan
CFO at Arista Networks

I mean, look, we, we, we haven't talked about backlog and orders. I think we've talked more just in terms of deployments and, and deployment slots. You know, if you think back to the, to my commentary, I mean, we do believe that there are, you know, ongoing deployments that will go well into 2024, right? It's not. You know, again, I don't necessarily sign up to the terminology of the backlog and the drawdown, et cetera, because it's just given how the orders and the patterns of the orders, it's very difficult to talk in that language, right? I think in terms of deployments, we will have deployments that are already planned and scheduled into, into 2024. I think, you know, we're taking it quarter by quarter through the end of the year, but I'd still go back to my kind of incremental.

Ita Brennan
Ita Brennan
CFO at Arista Networks

You know, look at, look at it kind of incrementally, quarter-over-quarter. You know, continue to show some improvement. Kind of we've guided Q3. Q4 is, you know, take some similar kind of incremental improvement into Q4. I think that's the way to think about it for now. Again, I don't know that it's. We, our commentary on kind of demand and lead time stands, right? I mean, as lead times shorten, you will see some period of time where customers don't need to place orders until you get back into lead time. That dynamic is certainly there. You know, as we get closer to the end of the year, we'll get more visibility into next year.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Tom, I think this-

Tal Liani
Tal Liani
Managing Director and Senior Research Analyst at Bank of America

So-

Tal Liani
Tal Liani
Managing Director and Senior Research Analyst at Bank of America

I know you asked a difficult question.

Tal Liani
Tal Liani
Managing Director and Senior Research Analyst at Bank of America

Sorry, Jayshree.

Tal Liani
Tal Liani
Managing Director and Senior Research Analyst at Bank of America

Kind of difficult question. Look, it's a, we'll know more as time goes on, we think the business is strong, and whether that comes in strongly in 2024 or 2025 or somewhere in between, we shall see, right? The reality is, it'll be difficult to repeat the last two years of exceptional cloud CapEx for cloud networking. As they go through that deployment and as they look at AI and as we bring in the enterprise and tier two cloud, we've got a nice mix of things. I, I urge everyone to think of our business, as Ira has always alluded to, not in 1 quarter or even 1 year, but really a 3-year CAGR. I think our 3-year CAGR will continue to be in double digits and good numbers.

Tal Liani
Tal Liani
Managing Director and Senior Research Analyst at Bank of America

Great. Thank you.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Thanks, Tal.

Operator

We'll take our next question from Sebastien Naji, with William Blair.

Sebastien Naji
Sebastien Naji
Analyst at William Blair

Great, thanks for taking the question. Can you maybe just update us on the visibility in your customer base? Is it still around six months, or are we now down closer to three months? Maybe just longer term, do you think that generative AI could help improve that visibility from where it's historically been, just given that many of these hyperscalers have what seems like decent visibility into a pretty robust pipeline over the next few years?

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Yeah, that's a really good question, Sebastien. You know, since we have so many products in the mix, I have to break your question into visibility across multiple areas. Enterprise, I would say 6-12 months, generally speaking. In the cloud, given the reduced lead times on classic cloud networking, it's less than 6 months. However, on AI it is greater, since it's an early cycle and we have to do a lot more joint development. You can think of it as, you know, 3 migrations going on with different visibility patterns.

Sebastien Naji
Sebastien Naji
Analyst at William Blair

Great, thanks.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Thanks, Sebastien.

Operator

We'll take our next question from Samik Chatterjee with JP Morgan.

Samik Chatterjee
Samik Chatterjee
Senior Analyst at JP Morgan

Hi, thanks. Thanks for taking my question. Maybe if I can shift gears here a bit to enterprise, Jayshree, obviously you're talking about the slowdown on the cloud side here a bit going into 2024, when you look at enterprise, how do you think about sustaining a growth rate or the slowdown in that growth rate into 2024? What are you seeing in terms of orders on that front to sort of give you visibility into 2024? Thank you.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Look, I think, Soumik, this, this is an area that we feel pretty good about, and it's an area of great execution from Ashok, Chris Schmidt, Ashwin, and the entire team, where we have really diversified our business, globally in the enterprise. We're not just in the high-end financials. We're in just about every major vertical: healthcare, transportation, public sector, education, banks, insurances. I feel enterprise, you know, barring any macro issue, which is the thing we were always worried about for 2024, so if macro doesn't let us down and we don't have to worry about the economy, we will have a strong year in enterprise.

Samik Chatterjee
Samik Chatterjee
Senior Analyst at JP Morgan

Thank you.

Operator

We'll take our next question from Aaron Rakers with Wells Fargo.

Aaron Rakers
Aaron Rakers
Managing Director and Senior Equity Analyst at Wells Fargo

Yeah, thank you for taking the question. I, I guess I wanted to ask just on product cycle cadence. You know, there's, there's a lot of focus from one of your key component suppliers on the merchant silicon side, around 51.2Tb silicon and obviously supporting the 800Gb cycle. I'm curious, how do you think about the timing of that? When do we start to see the materializing deployments of 800Gb? You know, maybe that's tied to AI, maybe it's not. Just, just curious of when that cycle, you believe, really starts to kick in.

Anshul Sadana
Anshul Sadana
COO at Arista Networks

Aaron, you know, we had the same discussion when the world went to 400Gb. Are we switching from 100 to 400? The reality was the customers continued to buy both 100 and 400 for different use cases. 51T and 800Gb especially are being pulled by AI clusters, the AI teams. They're very anxious to get their hands on it, move the data as quickly as possible and reduce their job completion times. You'll see early traction there. You'll see Jayshree mentioned trials really in 2024, going into volume in 2025, and that should be the ramp we'll follow for 800Gb. That does not mean everything they just bought last few years at 400Gb for DCI or the spines and so on, for classic clusters, is going to get upgraded to 800Gb.

Anshul Sadana
Anshul Sadana
COO at Arista Networks

I think that's going to be a longer cycle. You will see 100, 200, 400, and 800 get deployed in parallel as we enter that cycle in 2024, 2025.

Aaron Rakers
Aaron Rakers
Managing Director and Senior Equity Analyst at Wells Fargo

Thank you.

Anshul Sadana
Anshul Sadana
COO at Arista Networks

Thanks.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Thanks, Aaron.

Operator

We'll take our next question from Matthew Niknam with Deutsche Bank.

Matthew Niknam
Matthew Niknam
Analyst at Deutsche Bank

Hey, thanks for taking the question. I'm just wondering, on the supply chain, if you can talk about how that's evolved over the last quarter. As it relates to gross margins, I think you're messaging incremental improvements in 3Q and 4Q. Is that purely a function of easing supply chain, or is there also maybe greater relative contribution from enterprise relative to Cloud Titans envisioned in the second half of the year as well? Thanks.

Ita Brennan
Ita Brennan
CFO at Arista Networks

I mean, we're definitely seeing, you know, improvement on the supply chain side. We're seeing, you know, improvements with freight, improvements with, you know, just some of the expedite costs of the things that we were dealing with, and, you know, we're kind of inventoried, and now we're releasing them. I think we're coming out from underneath that. You know, there is some small shift in mix as well, but it's still a good, strong cloud mix, you know, this quarter, this year. You know, it's not like we're back to, you know, a heavy enterprise mix with cloud playing a much smaller part. There's still a very healthy kind of cloud mix in this, in this year. It's more where we can back out our, you know, the, the supply chain stuff that we'd incurred in the past.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Yeah. No, I want to give a shout-out, Mark Burkhart, our new Senior VP of Manufacturing, and John McCool, both in Anshul's team, have done a fantastic job of optimizing the supply chain. Those improvements are really playing a role in our quarter-to-quarter growth margins.

Ita Brennan
Ita Brennan
CFO at Arista Networks

Yeah.

Matthew Niknam
Matthew Niknam
Analyst at Deutsche Bank

Thank you.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Thanks.

Operator

We'll take our next question from James Fish with Piper Sandler.

James Fish
James Fish
Managing Director and Senior Research Analyst at Piper Sandler

Hey, thanks for the question. I just wanted to follow up around some of the prior questions asked, as many might have been asked already, but I know you guys aren't talking about visibility and don't discuss backlog, but is it still fair to assume that, you know, we should think about you guys returning to a normal environment from a supply perspective in the early part of next year? I believe, Ita, you've talked about, you know, underneath, assuming that hyperscalers or your Cloud Titans grow double digits for this year. Is it still fair to think about that kind of level for 2023?

Ita Brennan
Ita Brennan
CFO at Arista Networks

Yes, I think, I think absolutely right. I think that, you know, we kind of forget that cloud is still an important part of 2023, right? We're still, we're still executing on deployments and planning that we did some time back, right, all the way through this year. Cloud is still a significant piece of the, of the business in, in 2023.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Yes, James, just to confirm, we expect a more normal setting in 2024 in terms of lead time. You're right to assume that.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Thanks, James.

Operator

We'll take our next question from Simon Leopold with Raymond James.

Simon Leopold
Simon Leopold
Managing Director and Senior Equity Analyst at Raymond James

Thanks for taking the question. I wanted to see if you could maybe do a little bit of unpacking in terms of what's driving your enterprise business, in that I think the conventional wisdom is that enterprises are challenged by recessionary forces on the cycle, and then the secular challenge around public cloud adoption means slowing. So what do you see happening? How much of this is successes related to market share gains, how much to general cycles, products, et cetera? If we could unpack the enterprise traction. Thank you.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Sure, Simon. Well, of course, we have market share gains. That is the result of our enterprise traction, I would say. If you ask me, why are we winning in the enterprise? I would say, number 1, from an alternative perspective, our customers haven't had one for a very long time. They haven't had a high quality, high support, you know, very, very, you know, friendly software experience, a common least fine architecture across their data center, campus, routing in a long, long time. I think the architectural shift in the enterprise to move to a modern cloud operating model is the number 1 reason that Arista has been chosen. They, they are seeking our architecture for that quality experience. In fact, Anshul and I were just talking about the call.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

You know, we, we use the word cloudify a lot, and it, it, quite frankly, right now, that our high-end enterprises are really looking for the cloud principles, but however, on their premise. In terms of the shift between, you know, workloads on the cloud and workloads on the enterprise, it depends on the customer. You still see some of the mid-market customers want to move their e-commerce workloads on the cloud, but a lot of their mission-critical applications stay on the premise. A hybrid strategy continues to dominate the enterprise decisions for the data center. Secondly, our entry into the campus and routing, as well as zero trust, security, observability, et cetera, is adding more layers to the cake. Our product depth and breadth is getting better and better.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

The cloud operating model, the product depth, and now, actually, we've been at it now for, what do you say, Anshul, 3-5 years, maybe? Especially in the United States, we've got more work to do internationally. I would say we've been engaging with these customers. I remember when Ita and I had a discussion, I want to say 5 years ago, where she was right, and I was wrong, and she persuaded me to invest more in the enterprise. I think all these things have gone into really making us who we are in the enterprise, and today, we are a gold standard, and we have a seat at the table there.

Simon Leopold
Simon Leopold
Managing Director and Senior Equity Analyst at Raymond James

Thank you.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Thank you, Simon.

Operator

We'll take our next question from David Vogt with UBS.

David Vogt
David Vogt
Managing Director and Senior Equity Analyst at UBS

Great. Thanks, guys, for taking the question, and congratulations, Ita. I just want to go back to the point and maybe help bridge the 2023 to 2024 to 2025 commentary that Jayshree mentioned, sort of strong double-digit growth. I think in the past, you've talked about 15% growth across cycles, and I'm just trying to think through, you know, is there enough in trials and pilots in 2024 to kind of get you to that kind of mid-teens growth over the next couple of years? If not, does that mean that your enterprise business has to remain incredibly robust in 2024, you know, upwards of, you know, high teens to low 20% growth next year?

David Vogt
David Vogt
Managing Director and Senior Equity Analyst at UBS

I know you're not giving guidance, but trying to kind of walk the bridge to get from where we are today to 2025, where you're going to start to see more widespread AI deployments from a revenue recognition perspective. Thanks.

Ita Brennan
Ita Brennan
CFO at Arista Networks

Now you want us to go to 25 as well? I, I don't think we're ready to do that. That's, that's a really good conversation for the end of the day, honestly. I think, you know, we obviously, you know, we're very focused internally, as Jayshree reiterated earlier on, the businesses is a lot more robust with many different drivers. you know, as you go through that period, cloud will ebb and flow, but it's still a, a healthy business and has been a healthy business through those cycles. you know, I think we've got a lot of the building blocks, but the how we're going to assemble them, maybe we'll save for the Analyst Day.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

We'll share the Lego plan more.

Ita Brennan
Ita Brennan
CFO at Arista Networks

Yeah.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

David, rest assured that, that we are aiming for at least, at least double digits next year, and so we'll go from there.

David Vogt
David Vogt
Managing Director and Senior Equity Analyst at UBS

Great. Thanks, guys, and congrats again.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Thank you.

Ita Brennan
Ita Brennan
CFO at Arista Networks

Thank you.

Operator

We'll take our next question from Erik Suppiger with JMP Securities.

Erik Suppiger
Erik Suppiger
Senior Research Analyst at JMP Securities

Yeah, thanks for taking the question. Maybe this is for Anshul? Can you just walk us through kind of how the Cloud Titans work? We, we hear a lot about them, buying, volumes of GPUs right now. At what point do, do, do their purchasing of GPUs translate into their demand for, for switches? How, how does it work with the trials and, and so on and so forth?

Anshul Sadana
Anshul Sadana
COO at Arista Networks

You know, there, there is no uniform recipe, but in general, when they're buying GPUs close to connect. These could be out a few quarters, depending on their timing of deployments. Do they build the network first? - These are very large things. It takes them a couple of months, sometimes a quarter or more, to fine-tune the cluster and benchmark and test everything before it is actually released to production. You can think of that as sort of the basis, a couple of months, couple of quarters minimum, before you can get there. Sometimes it adds up to about a year before you really ramp into production.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Great. Thanks, Erik.

Erik Suppiger
Erik Suppiger
Senior Research Analyst at JMP Securities

Thanks.

Operator

We'll take our next question from George Notter with Jefferies.

George Notter
George Notter
Managing Director and Analyst at Jefferies

Hi, guys. Thanks a lot. I guess I wanted to ask about your comments about 2025 participation in AI. Can you walk us through sort of the milestones that you see between now and then in terms of, you know, increasing Arista's participation? Certainly, there's new product development, there's market acceptance, I, I presume. You know, and then, and then also, I, I assume that you participate today with inferencing applications, and that's by and large done on Ethernet. I, I think what we're really talking about is training, correct? Any more color there would be great. Thanks.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Yes, George. I think you can look at 2023 as really a year of planning for AI, because as I said, you know, there's tons and tons of GPUs being purchased, and then the question is, how is it being connected? Depending on whether they're small, medium, or large, there are different technologies, but I'm going to stay focused on the large because that's the biggest problem. You are right to say some of them may be Ethernet or even a non-networking technology, just an IO or a bus, for smaller networks. Generally speaking, we're focusing on things that are much larger than, you know, 200 or even 1,000 GPUs. That's the first thing. A lot of planning is going into that, and the planning basically is, how do they get the GPUs? What is their application?

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

What is the size of the cluster? What is the time? What is the large language model data sets, et cetera? What is their network foundation? In some cases where they just need to go quick and fast, as I explained before, it would not be uncommon to just bundle their GPUs with an existing technology like InfiniBand. Where they're really rolling out into 2025, they're doing more trials and pilots with us to see what the performance is, to see what the drop is, to see how many they can connect, what's the latency, what's the better entropy, what's the efficiency, etc. That's where we are today. We expect next year this will translate to some, what I call pilots, because majority of them will happen in 25, but in 24 you'll start seeing... What do you say, Anshul?

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Maybe, you know, 4,000-8,000 GPUs, something like that.

Anshul Sadana
Anshul Sadana
COO at Arista Networks

That's right, in that range.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

In that range, okay. 4,000 to 8,000 GPUs at about 400Gb type clusters, we will actually put some production workloads on it. I call them smaller pilots. The real test of why you buy these expensive GPUs is in 2025, when you want to have not just 4 to 8, but 30,000, 50,000, maybe even 100,000. This is why 2025 is so critical. Taking, testing and taking out all the kinks, you know, out of the GPUs and networks is important because your network is so a good network is so pivotal to getting the most out of your GPUs. If you have idling cycles on those GPUs, you wasted thousands, if not millions of dollars.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

I think this, these next 2 years are crucial to getting the most out of these expensive GPUs, and that's where the network really comes in. Anshul?

Anshul Sadana
Anshul Sadana
COO at Arista Networks

If I can add one more thing here. What are the milestones to get to these 2025 large-scale GPU deployments? There is one key milestone that has nothing to do with GPUs or our switches, which is, does the customer have enough power on the site...

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Uh-huh

Anshul Sadana
Anshul Sadana
COO at Arista Networks

ready to deploy that many megawatts or gigawatts of capacity? As you know, getting a 50, 100-megawatt site takes a couple of years, which is why this is a slow ramp. This is not suddenly turn on the key and you have thousands of GPUs.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Yeah, really good point. Simple things like power and space are still vital.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Thanks, George.

Operator

We'll take our next question from Karl Ackerman with BNP Paribas.

Karl Ackerman
Karl Ackerman
Research Analyst at BNP Paribas

Yes, thank you. Jayshree, there's been some investor concern that hyperscale customers may focus more on white box solutions for 800Gb than in the 400Gb cycle. We're aware that some of your customers continue to adopt a dual sourcing strategy, but if you could just comment on the potential for an upgrade cycle as well as reuse risk on the transition to 800Gb, it would be very helpful. Thank you.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Sure. As, as you're probably well aware, the white box question has remained with Arista as the one of the most popular questions asked right from the time of our IPO. Whether it's, 10Gb, 40Gb, 100Gb, 400Gb, or now you ask it at 800Gb. I, I think there will always be an element of white box if somebody's just looking to build something and throw in some quick traffic. For some of these most mission-critical networks, it's less about the box and more about the software stack, and how much performance, availability, power, you, you really get out of this. The cost of putting in the box, if you save something, if you even save something, is far dwarfed by the total OpEx you need to make that box work.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

We continue to believe that we will coexist with white box and some of our Cloud Titan customers. We will continue to run both SONiC and FBOSS in the case of Microsoft and Meta, along with our EOS. But at the end of the day, whether it's a white box or a blue box, it's the software stack that really wins.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Thanks, Karl. Operator, we have time for one last question.

Operator

Thank you. We'll take our last question from Ben Reitzes with Melius Research.

Ben Reitzes
Ben Reitzes
Partner and Head of Technology Research at Melius Research

Hey, thanks a lot for sneaking me in there. Congratulations, Jayshree and team. wanted to ask about enterprise again. I think, you know, the comments you made around Cloud Titans were all things that people were able to detect, the enterprise just seems so much better in terms of the performance and the guide. You mentioned that you gained share, did the market pick up as well? Do you see that market pick up in demand in the enterprise sustaining into 2024? Just kind of more color around enterprise and, whether, you know, the market picked up in addition to you gaining share.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Hey, Ben. Thank you. What do you mean by the market pick up? I don't follow the question.

Ben Reitzes
Ben Reitzes
Partner and Head of Technology Research at Melius Research

Did, did, did demand pick up?

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Oh.

Ben Reitzes
Ben Reitzes
Partner and Head of Technology Research at Melius Research

The enterprise outperformance was quite a surprise, and clearly, the Cloud Titan commentary was, you know.

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Yeah

Ben Reitzes
Ben Reitzes
Partner and Head of Technology Research at Melius Research

... subdued as everybody was able to predict after the last conference calls this week. I mean...

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

Yeah, yeah.

Ben Reitzes
Ben Reitzes
Partner and Head of Technology Research at Melius Research

was it all market share, or is the market picking up? Is, is demand picking up across the board?

Jayshree Ullal
Jayshree Ullal
CEO at Arista Networks

I, I would say to you that probably our enterprise demand has always been strong and not subdued, far from that. However, dwarfed by the excellence of our cloud performance, you didn't notice it, and now you're noticing it.

Liz Stein
Liz Stein
Director of Investor Relations at Arista Networks

Thanks, Ben. This concludes the Arista Networks second quarter 2023 earnings call. We have posted a presentation which provides additional information on our results, which you can access on our investor section of our website. Thank you for joining us today, and thank you for your interest in Arista.

Operator

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

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