Yahoo Finance Arista Networks, Inc. (NYSE:ANET) Q1 2024 Earnings Call Transcript
Arista Networks, Inc. (NYSE:ANET) Q1 2024 Earnings Call Transcript May 7, 2024
Arista Networks, Inc. beats earnings expectations. Reported EPS is $1.99, expectations were $1.74. Arista Networks, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Ladies and gentlemen, welcome to the First Quarter 2024 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. [Operator Instructions] 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 Stine, Arista's Director of Investor Relations, you may begin.
Liz Stine: Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me on today's call are Jayshree Ullal, Arista Networks' Chairperson and Chief Executive Officer and Chantelle Breithaupt, Arista's Chief Financial Officer. This afternoon, Arista Networks issued a press release announcing the results for its fiscal first quarter ending March 31st, 2024. If you'd like a copy of this release, you can access it online from our website. During the course of this conference call, Arista Networks' management will make forward-looking statements, including those relating to our financial outlook for the second quarter of the 2024 fiscal year, longer-term financial outlooks for 2024 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 and 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. 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: Thank you Liz. Thank you everyone for joining us this afternoon for our first quarter 2024 earnings call. Amidst all the network consolidation, Arista is looking to establish ourselves as the pure-play networking innovator for the next era, addressing at least a $60 billion TAM in data-driven client to cloud AI networking. In terms of Q1 specifics, we delivered revenue of $1.57 billion for the quarter with a non-GAAP earnings per share of $1.99. Services and software support renewals contributed strongly at approximately 16.9% of revenue. Our non-GAAP gross margins of 64.2% was influenced by improved supply chain and inventory management, as well as favorable mix of the enterprise. International contributions for the quarter registered at 20% with the America strong at 80%.
As we kick off 2024, I'm so proud of the Arista teamwork and our consistent execution. We have been fortunate to build a seasoned management team for the past 10 to 15 years. Our co-founders are very engaged in the company for the past 20 years. Ken is still actively programming and writing code, while Andy is our full-time chief architect for next generation AI, silicon and optics initiatives. Hugh Holbrook, our recently promoted Chief Development Officer, is driving our major platform initiatives in tandem with John McCool and Alex on the hardware side. This engineering team is one of the best in tech and networking that I have ever had the pleasure of working with. On behalf of Arista though, I would like to express our sincere gratitude for Anshul Sadana’s 16 plus wonderful years of instrumental service to the company in a diverse set of roles.
I know he will always remain a well-wisher and supporter of the company. But Anshul, I'd like to invite you to say a few words.
Anshul Sadana: Thank you, Jayshree. The Arista journey has been a very special one. We've come a long way from our startup days to over an $80 billion company today. Every milestone, every event, the ups and downs are all etched in my mind. I've had a multitude of roles and learned and grown more than what I could have ever imagined. I have decided to take a break and spend more time with family. Especially when the kids are young. I'm also looking at exploring different areas in the future. I want to thank all of you on the call today. Our customers, our investors, our partners, and all the well-wishers over these years. Arista isn't just a workplace, it's family to me. It's the people around you that make life fun. Special thanks to Arista leadership.
Chris, Ashwin, John McCool, Mark Frost, Eta and Chantel, Mark Taxi, Hugh Holbrook, Ken Duda, and many more. Above all, there are two very special people I want to thank. Andy Bechtolsheim, for years of vision, passion, guidance, and listening to me. And of course, Jayshree. She hasn't been just my manager, but also my mentor and coach for over 15 years. Thank you for believing in me. I will always continue to be an Arista well-wisher. Back to you, Jayshree.
Jayshree Ullal: Anshul, thank you for that very genuine and heartfelt expression of your huge contributions to Arista. It gives me goosebumps hearing your nostalgic memories. We will miss you and hope someday you will return back home. At this time, Arista will not be replacing the COO role and instead flattening the organization. We will be leveraging our deep bench strength of our executives who stepped up to drive our new Arista 2.0 initiatives. In particular, John McCool, our Chief Platform Officer, and Ken Kiser, our Group Vice President, have taken expanded responsibility for our cloud, AI, Titan initiatives, operations, and sales. On the non-cloud side, two seasoned executives are being promoted. Ashwin Kohli, Chief Customer Officer, and Chris Schmidt, Chief Sales Officer, will together address the global enterprise and provide our opportunity.
Our leaders have grown up in Arista for a long time with long tenures of a decade or more. We are quite pleased with the momentum across all our three sectors, cloud and AI, Titan, enterprise, and providers. Customer activity is high as Arista continues to impress our customers and prospects with our undeniable focus on quality and innovation. As we build our programmable network underlays based on our universal least-bind topology, we are also constructing networks as a service suite of overlays, such as Zero Touch Automation, Security, Telemetry, and Observability. I would like to invite Ken Duda, our Founder, CTO, and recently elected to the Arista board to describe our enterprise NAS strategy as we drive to our enterprise campus goal of 750 million in 2025.
Over to you, Ken.
Ken Duda: Thank you, Jayshree, and thanks everyone for being here. I'm Ken Duda, CTO of Arista Networks, excited to talk to you today about NetDL, the Arista Network Data Lake, and how it supports our network as a service strategy. From the inception of networking decades ago, networking has involved rapidly changing data, data about how the network is operating, which paths through the network are best, and how the network is being used. But historically, most of this data was just simply discarded as the network changed the state, and that which was collected can be difficult to interpret because it lacks context. Network addresses and port numbers by themselves provide little insight into what users are doing or experiencing.
Recent developments in AI have proved the value of data, but to take advantage of these breakthroughs, you need to gather and store large data sets labeled suitably for machine learning. Arista is solving this problem with NetDL. We continually monitor every device, not simply taking snapshots, but rather streaming every network event, every counter, every piece of data in real time, archiving a full history in NetDL. Alongside this device data, we also collect flow data and in-band network telemetry data gathered by our switches. Then, we enrich this performance data further with user service and application layer data from external sources outside the network, enabling us to understand not just how each part of the network is performing, but also which users are using the network for what purposes, and how the network behavior is influencing their experience.
NetDL is a foundational part of the EOS stack, enabling advanced functionality across all of our use cases. For example, in AI Fabrics, NetDL enables fabric-wide visibility, integrating network data and NIC data to enable operators to identify misconfigurations or misbehaving hosts, and pinpoint performance bottlenecks. But for this call, I want to focus on how NetDL enables network as a service. Network as-a-Service, or NAS, is Arista's strategy for up-leveling our relationship with our customers, taking us beyond simply providing network hardware and software by also providing customers or service provider partners with tools for building and operating services. The customer selects a service model, configures service instances, and Arista's CV-NAS handles the rest, equipment selection, deployment, provisioning, building, monitoring, and troubleshooting.
In addition, CV-NAS provides end-user self-service, enabling customers to manage their service instance, provision new endpoints, provision new virtual topologies, set traffic prioritization policies, set access rules, and get visibility into their use of the service and its performance. One can think of NAS as applying cloud computing principles to the physical network, reusable design patterns, scale autonomous operations, multi-tenant from top to bottom with cost-effective automated end-user self-service. And we couldn't get to the starting line without NetDL, as NetDL provides the database foundation of NAS service deployment and monitoring. Now, NAS is not a separate SKU, but really refers to a collection of functions in Cloud Vision. For example, Arista Validated Designs, or AVD, is a provisioning system.
It's an early version of our NAS service instance configuration tool. Our AGNI services provide global location-independent identity management needed to identify customers within NAS. Our UNO product, or universal network observability, will ultimately become the service monitoring element of NAS. And finally, our NAS solution has security integrated through our ZTN, or Zero Trust Networking, product that we showcased at RSA this week. Thus, our NAS vision simultaneously represents a strategic business opportunity for us, while also serving as a guiding principle for our immediate Cloud Vision development efforts. While we are really excited about the future here, our core promise to our investors and customers is unchanging and uncompromised.
We will always put quality first. We are incredibly proud of the amount of success customers have had deploying our products, because they really work. And as we push hard, building sophisticated new functions in the NetDL and NAS areas, we will never put our customers' networks at risk by cutting orders on quality. Thank you.
Jayshree Ullal: Thank you, Ken, for your tireless execution in the typical Arista way. In an era characterized by stringent cybersecurity, observability is an essential perimeter and imperative. We cannot secure what we cannot see. We launched CloudVision UNO in February 2024 based on the EOS Network Data Lake Foundation that Ken just described for Universal Network Observability. CloudVision UNO delivers fault detection, correction, and recovery. It also brings deep analysis to provide a composite picture of the entire network with improved discovery of applications, hosts, workloads, and IT systems of record. Okay, switching to AI, of course, no call is complete without that. As generative AI training tasks evolve, they are made up of many thousands of individual iterations.
Any slowdown due to network can critically impact the application performance, creating inefficient wait states, and idling away processor performance by 30% or more. The time taken to reach coherence, known as job completion time, is an important benchmark achieved by building proper scale-out AI networking to improve the utilization of these precious and expensive GPUs. Arista continues to have customer success across our innovative AI for networking platforms. In a recent blog from one of our large Cloud and AI Titan customers, Arista was highlighted for building a 24,000-node GPU cluster based on our flagship 7800 AI Spine. This cluster tackles complex AI training tasks that involve a mix of model and data parallelization across thousands of processors, and Ethernet is proving to offer at least 10% improvement of job completion performance across all packet sizes versus InfiniBand.
We are witnessing an inflection of AI networking and expect this to continue throughout the year and decade. Ethernet is emerging as a critical infrastructure across both front-end and back-end AI data centers. AI applications simply cannot work in isolation and demand seamless communication among the compute nodes consisting of back-end GPUs and AI accelerators, as well as the front-end nodes like the CPUs alongside storage and IPWAN [ph] systems as well. If you recall, in February, I shared with you that we are progressing well in four major AI Ethernet clusters that we won versus InfiniBand recently. In all four cases, we are now migrating from trials to pilots, connecting thousands of GPUs this year, and we expect production in the range of 10K to 100K GPUs in 2025.
Ethernet at scale is becoming the de facto network and premier choice for scale-out AI training workloads. A good AI network needs a good data strategy delivered by a highly differentiated EOS and network data lake architecture. We are therefore becoming increasingly constructive about achieving our AI target of 750 million in 2025. In summary, as we continue to set the direction of Arista 2.0 networking, our visibility to new AI and cloud projects is improving, and our enterprise and provider activity continues to progress well. We are now projecting above our analyst-day range of 10% to 12% annual growth in 2024. And with that, I'd like to turn it over to Chantelle for the very first time as Arista CFO to review financial specifics and tell us more.
Warm welcome to you, Chantelle.
Chantelle Breithaupt: Thank you, Jayshree, and good afternoon. The analysis of our Q1 results and our guidance for Q2 2024 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 $1.571 billion, up 16.3% year-over-year, and above the upper end of our guidance of $1.52 billion to $1.56 billion. This year-over-year growth was led by strength in the enterprise vertical, with cloud doing well as expected. Services and subscription software contributed approximately 16.9% of revenue in the first quarter, down slightly from 17% in Q4.
International revenues for the quarter came in at $316 million, or 20.1% of total revenue, down from 22.3% in the last quarter. This quarter-over-quarter reduction reflects the quarterly volatility and includes the impact of an unusually high contribution from our EMEA in-region customers in the prior quarter. In addition, we continue to see strong revenue growth in the U.S. with solid contributions from our Cloud Titan and Enterprise customers. Growth margin in Q1 was 64.2% above our guidance of approximately 62%. This is down from 65.4% last quarter and up from 60.3% in Q1 FY23. The year-over-year margin accretion was driven by three key factors. Supply chain productivity gains led by the efforts of John McCool, Mike Kappus, and his operational team, a stronger mix of enterprise business and a favorable revenue mix between product, services, and software.
Operating expenses for the quarter were $265 million or 16.9% of revenue up from last quarter at $262.7 million. R&D spending came in at $164.6 million or 10.5% of revenue down slightly from $165 million last quarter. This reflected increased headcount offset by lower new product introduction costs in the period due to timing of prototypes and other costs associated with our next generation products. Sales and marketing expense was $83.7 million or 5.3% of revenue compared to $83.4 million last quarter with increased headcount costs offset by discretionary spending that is delayed until later this year. Our G&A costs came in at $16.7 million or 1.1% of revenue up from 0.9% of revenue in the prior quarter. Income from operations for the quarter was $744 million or 47.4% of revenue.
Other income for the quarter was $62.6 million and our effective tax rate was 20.9%. This resulted in net income for the quarter of $637.7 million or 40.6% of revenue. Our diluted share number was 319.9 million shares resulting in a diluted earnings per share number for the quarter of $1.99 up 39% from the prior year. Now turning to the balance sheet. Cash, cash equivalents and investments ended the quarter at approximately $5.45 billion. During the quarter we repurchased $62.7 million of our common stock and in April we repurchased an additional $82 million for a total of $144.7 million at an average price of $269.80 per share. We have now completed share repurchases under our existing $1 billion board authorization whereby we repurchased 8.5 million shares at an average price of $117.20 per share.
In May 2024 our board of directors authorized a new $1.2 billion stock repurchase program which commences in May 2024 and expires in May 2027. The actual timing and amount of future repurchases will be dependent upon market and business conditions, stock price and other factors. Now turning to operating cash performance for the first quarter, we generated approximately $513.8 million of cash from operations in the period reflecting strong earnings performance partially offset by ongoing investments and working capital. DSOs came in at 62 days up from 61 days in Q4 driven by significant end of quarter service renewals. Inventory turns were one flat to last quarter. Inventory increased slightly to $2 billion in the quarter up from $1.9 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 are $1.5 billion down from $1.6 billion at the end of Q4. We expect this number to level off as lead times continue to improve but will remain somewhat volatile as we ramp up new product introductions. Our total deferred revenue balance was $1.663 billion up from $1.506 billion in Q4 fiscal year 2023. 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. Our product deferred revenue balance decreased by approximately $25 million versus last quarter. We expect 2024 to be a year of significant new product introductions, new customers and expanded use cases. These trends may result in increased customer specific acceptance clauses and increase the volatility of our product deferred revenue balances.
As mentioned in prior quarters, the deferred balance can move significantly on a quarterly basis independent of underlying business drivers. Accounts payable days were 36 days down from an usually high 75 days in Q4 reflecting the timing of inventory receipts and payments. Capital expenditures for the quarter were $9.4 million. Now, turning to our outlook for the second quarter and beyond. I have now had a quarter of working with Jayshree, the leadership team, and the broader Arista ecosystem, and I am excited about both our current and long-term opportunities in the markets that we serve. The passion for innovation, our agile business operating model, and employee commitment to our customer success are foundational. We are pleased with the momentum being demonstrated across the segments of enterprise, cloud, and providers.
With this, we are raising our revenue guidance to an outlook of 12% to 14% growth for fiscal year 2024. On the gross margin front, given the expected end-customer mix combined with continued operational improvements, we remain with a fiscal year 2024 outlook of 62% to 64%. Now, turning to spending and investments, we continue to monitor both the overall macro environment and overall market opportunities, which will inform our investment prioritization as we move through the year. This will include a focus on targeted hires and leadership roles, R&D, and the go-to-market team as we see opportunities to acquire strong talent. On the cash front, while we will continue to focus on supply chain and working capital optimization, we expect some continued growth in inventory on a quarter-by-quarter basis as we receive components from our purchase commitments.
With these sets of conditions and expectations, our guidance for the second quarter, which is 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 $1.62 billion to $1.65 billion, gross margin of approximately 64%, and operating margin at approximately 44%. Our effective tax rate is expected to be approximately 21.5%, with diluted shares of approximately 320.5 million shares. I will now turn the call back to Liz for Q&A. Liz?
Liz Stine: Thank you, Chantelle. 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.
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