Q2 2021 Arista Networks Inc Earnings Call
[music].
Welcome to the second quarter 2021 of 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 and instructions will be provided at that time, Inc.
Anytime during the conference you need to reach an operator. Please press the star followed by zero as a reminder of this conference is being recorded and will be available for replay from the Investor Relations section at the Arista website. Following this call.
Now I'll turn the call over to Mr. Charles Yager director of product and Investor advocacy shares may begin.
Thank you operator, good afternoon, everyone and thank you for joining US with me on today's call of Jase real all Arista networks, President and Chief Executive Officer, and eat of Brendan Arista Chiefs Arista Chief Financial Officer. This afternoon, Arista networks issued a press release announcing the results for its fiscal second quarter ending June 30th 'twenty 'twenty 1.
If you'd like a copy of the release you can access it on line at 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 third quarter of the 2021 fiscal year longer term financial outlooks for 'twenty, 'twenty, 1 and beyond our total addressable market and.
G for addressing these market opportunities the potential impact of COVID-19 on our business product innovation and the benefits of acquisition, 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 <unk>.
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've 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 Jay Sri Thank you Charles Thank you everyone for joining us. This afternoon for our second quarter of 2021 earnings call. I Hope you are all being safe and vaccinated in these post pandemic times, especially with the resurgence of the Delta variant.
I would also like to take this opportunity to warmly welcome. This time on new director of Investor Relations advocacy working closely with China. This is a long time of Arista and with deep networking expertise and most recently ran on south Central region as the systems engineering manager of welcome debt.
Back to Q2, 2021 specifics, we delivered revenues of $707.3 million for the quarter with a record non-GAAP earnings per share of $2.72 AK.
Okay services and software renewals contributed approximately 22 percentage of revenue on.
Non-GAAP gross margins of 65, 2% was influenced by an enterprise momentum in software and services contribution.
We are pleased with the healthy customer traction, including new customer logos and record of million dollar customers in the mainstream enterprise.
In Q2, 2021 cloud Titans, where our largest vertical the enterprise was a close second followed by financials of specialty cloud providers tied of third place and service provider at fourth place.
International contribution was strong at 27% with the Americas at 73 per cent for the quarter.
We surpassed the cumulative of 50 million cloud networking port shipments this quarter and we can say that this can be of key golden milestone.
In light of day industry wide supply chain shortages and escalating cost of components freight and expedite logistics I would like to invite John Mccool, Our senior Vice President and Chief platform Officer to shed some more light on our manufacturing execution welcomed Joel thanks tax free to continued industry wide impact of <unk>.
But on global supply chain output combined with increase in demand for electronics across all segments is expected to remain for the foreseeable future.
Lead times of the highest we've seen and of roughly double from pre pandemic dorms.
Notably our semiconductor lead times, which sort of extended the range of 40 to 60 weeks factories are operating near full capacity limiting flexibility for changes in demand.
Therefore, we expect extended lead times on escalating product costs due to expedites and elevated component increases in 2021 and 2022.
To mitigate these headwinds we've taken a number of steps on Arista manufacturing personally improved manufacturing procedures to maximize capacity of material utilization.
We are increasing our purchase commitments for 2022 forecast to adjust for increased component lead times, we placed additional emphasis on inventory for our new products to offset supply constraints.
Finally, we are working closely with our strategic suppliers to plan for capacity expansion programs. Clearly we are redoubling, our efforts and execution in this challenging macro environment and look forward to supply chain improvements on the second half of 2022 and beyond back to use of Sri.
Thanks, John.
Really appreciate the diligent and disciplined work that you and the entire manufacturing team has stepped up to we welcome Susan Hey, your newest Vice President of manufacturing is a strong addition.
We also thank our customers for their patience and understanding during on lead time constraints and will strive to keep doing better as we recover in second half of 2022.
Our enterprise customer momentum has never been stronger continuing on that theme of enterprise wins I would like to share with you 3 examples of strength and success. The first win was in the retail sector for both data center on campus, we began with the data center win but the risk of hallmark.
Pos for Dan or data analysis, switching and routing we expanded in 2021 of the cognitive campus for both power over Ethernet wired switches and wireless providing a natural expansion into these use cases.
Retail market cannot tolerate downtime with the magnitude of Iot proliferation. They have Arista was able to perform real time upgrades without downtime across hundreds of stores and warehouses.
And the absence of retailed remote staff on hand, we drove automation across all of these stores with open API and cloud vision.
Our second win was a major U S financial for both data center and routing.
Mr continues to expand its enterprise routing use cases, not just supporting with data center with Arista Eos features but also of more software led simplified automated deployment of core routing in the spine using standard space, writing protocols of VX Lan EVP N on multi cast.
Our customer was able to rapidly migrate from legacy to Arista within a few months, enabling billions of transactions.
And International Media and Entertainment campus wins included a customer who wanted an extension of their data center on the campus with simple operating system easy to scale common spine deployment using cloud division. This customer took of build as you go approach of flexibility and visibility.
Also included device access for back to work application without cognitive Wifi.
And all of these 3 examples enterprise customers, who refer on alternatives and the rest of it was chosen as the disruptor with superior product capability and a cohesive client to cloud strategy to unify Sino datasets consistently.
Best of innovations combined with high quality and support is becoming the gold standard for customers to build cognitive cloud networking.
According to industry experts of Arista continues to gain switching market share across large enterprises on providers. We are proud to be the number 1 market leader in 100 gigabit Ethernet ports for the fifth consecutive year we.
We see 2021 as of first year of inflection for higher speeds ranging from hundreds of 200 to 400 gig gigabit. After 18 months of trials, we have now shipped more than $2.5 million ports of high performance sports in the first half of 2021according to analysts, placing US also at number 1 leadership and the combined.
100 gig 200 gig and 400 gigabit Ethernet high performance cloud switching.
In summary of Arista is well positioned for the next phase of our growth in cloud and data driven networking. We do this with proactive platforms predictive operations on a prescriptive experience and we believe we are poised to achieve increasing market share with greater business diversification.
And lots of path forward is paved with supply chain of obstacles volatile customer demand and your normal typical competitive tactics I believe of Arista, which means to be great in Greek we live up to its name and with our a game on 8 customers and on a team with this I'll pass it over to each of our Chief Financial Officer.
For financial specifics.
Thanks, Joshua and good afternoon.
Since of our Q2 results on our guidance for Q3 is based on non-GAAP and excludes on noncash stock based compensation impacts certain acquisition related charges and other nonrecurring items of.
A full reconciliation of our selected GAAP to non-GAAP results is provided in our earnings release.
Total revenues in Q2 were $707.3 million up 38% year over year, and well above the upper end of our guidance of $675 million to $695 million.
Shipments remained somewhat constrained on the period as we continued to carefully navigate industry wide supply chain shortages and COVID-19 related disruptions.
Services and subscription software contributed approximately $22.3 per cent of revenue in the second quarter up from 21.4 per cent in Q1.
International revenues from the quarter came in at $193.2 million or 27 per cent of revenue up from 25% in the first quarter.
This shift in geographical mix on a quarter over quarter basis effect of strong international deployments by our cloud Titan on specialty club customers combined with healthy performance from our in region businesses.
Overall gross margin in Q2 was 65, 2% above the upper end of our guidance range of approximately 63% to 65%.
While we recognize some incremental supply chain costs in the period. These were more than offset by a healthy mix of enterprise on software revenue for the quarter.
Operating expenses for the quarter were $189.8 million or 26, 8 percentage of revenue up from last quarter at $180.9 million.
R&D spending came in at $119.6 million or 16, 9 percentage of revenue up from last quarter at $110 million.
This reflected increased employee related costs and higher new product introduction spending tens of period.
Sales and marketing expense of 57 million of 8.2 percentage of revenue down from $59.5 million last quarter with low of demo related expenses tens of period.
As a reminder, we continue to benefit from lower Covid related travel and marketing expenses.
Our G&A costs came in at $12.3 million of 1.7 per cent of revenue.
A bad quarter.
Our operating income for the quarter was $271.7 million or $38.4 per cent of revenue on.
Other income and expense for the quarter was a favorable $1.7 million on our effective tax rate was approximately 27%.
Collecting on improved geographical mix.
Other income and expenses for the quarter included approximately 2 million of interest income offset by some unfavorable FX of months.
This resulted in net income for the quarter of $216.8 million of 36 per cent of revenue.
Our diluted share of number was $79.7 1 million shares resulting in a diluted earnings per share of number for the quarter of $2.72 up.
Up approximately 29% from the prior year.
Now turning to the balance sheet cash cash equivalents and investments ended the quarter on approximately $3.3 billion.
We did not repurchase shares of our common stock during the second quarter.
As a recap, we've now repurchased $763 million or $3.6 million shares against our board authorization to repurchase $1 billion worth of shares over 3 years commencing in Q2.19, we will continue to execute opportunistically against the remaining mandate.
Turning to operational cash performance from the second quarter, we generated $263 million of cash from operations as of period.
Reflecting solid net income performance and continued investments in inventory and supply chain.
Dsos came in at 47 days down from 51 days in Q1 affecting the linearity of billings in the period.
Inventory turns were 1.7 times down slightly from last quarter at 1.8.
Inventory increased to $543.2 million in the quarter up from $483.2 million in the prior period, we continued to buffer of certain components of product.
Our total deferred revenue balance of $746 million up from $720 million in Q1.
The majority of the deferred revenue balance of services related and is directly linked to the timing and terms of service renewals, which can vary on a quarter by quarter basis.
Approximately $90 million of the balance up from $17 million last quarter represents product deferred revenue largely of in Asia to acceptance clauses for new products across various customers M sectors.
As a reminder, we expect 2021 to be a year of significant new product introductions combined with a healthy new customer acquisition rate and expanded use cases with existing customers.
These trends in conjunction with reduced levels of upfront and price and testing May result in increased customer specific acceptance clauses and increase volatility in our product deferred revenue amounts.
Accounts payable days were $53.7 days up from 52.3 days in Q1, reflecting the timing of inventory receipts of payments.
Capital expenditures for the quarter.
$4.5 million.
Now turning to the outlook for the third quarter and beyond.
We reported strong year over year revenue growth of approximately 29% for the first half 2021 affecting healthy demand across all of our market sectors combined with favorable comparisons from the first half of 2020.
While we expect continued strength in demand as we move through the second half, we will likely see some deceleration in year over year revenue growth.
Given the top line recovery experience in the back half of 2020.
Turning to gross margin industry supply constraints continued to pressure component cost.
Some of these incremental possible initially became a part of this inventory and only be recognized on the income statement 1 of the products are sold in future periods.
With this as context, we would continue to reiterate our gross margin outlook of $63.65 per cent with customer mix remaining of the key driver of volatility on a quarter by quarter basis.
Turning to spending and investments we remain committed to growing our investments in R&D to support innovation across the business and sales and marketing to support our go to market expansion.
With regard to cash flow, we expect to fund approximately $40 million of Capex from the third quarter for the purchase of land to those of datacenter and engineering location in Santa Clara will provide more details on this project over the coming quarters.
Finally, our outlook discussion discussed above and our guidance for Q3 reflects our current understanding of COVID-19, and its impact to our business from supply chain.
This remains an inherently uncertain situation and we will need to continue to monitor and attempt to mitigate new challenges as the situation unfolds.
With all of this as a backdrop our guidance for the third quarter, just based on non-GAAP results and excludes any noncash stock based compensation impacts and other nonrecurring items is as follows.
Revenues of approximately $725 million to $745 million gross margin of 63 to 65 per cent operating margin of approximately 37 per cent.
Our effective tax rate is expected to be approximately 21, 5% with diluted shares of approximately 80 million shares I will now turn the call back to Charles Charles. Thank you Ryder, we're now going to move to the Q&A portion of the Arista earnings call due to time constraints I'd like to request that everyone. Please limit themselves to a single question. Thank you for.
Your understanding of Peter take it away.
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 1 on your telephone keypad. If you like to withdraw your question press. The pound key we ask that you pick up your handset before asking questions in order to ensure optimal sound quality of your first question comes from the.
Line of meta Marshall with Morgan Stanley.
Great. Thanks, guys.
And there'll be a couple of questions on this today, but just if you could give a sense of.
If the supply chain constraints.
Worsen any portion of the portfolio and then maybe as it relates to that where are the inventory is I guess just trying to get a sense of is it on kind of the high speed products or more of the campus service provider of portfolio. Thanks.
Thanks net aren't yet.
I think just about every component is affected in our supply chain I'll, let John comment.
Comment, but were affected on chip memory copper of passive components of straight logistics expedite fees you I don't know if I can pinpoint so it affects all our products.
And the lead times of areas you heard David all doubled so we we've been experiencing anywhere from you know.
20 weeks to 16 weeks of 40 weeks of 60 weeks like you said you're on right. So depending on the part we are experiencing component levels of increase across the board.
Campus routing switching datacenter you name it and they are at the component level and now we're going to try and absorb as much of it and offset as much of that of as we can and not pass it onto our customers. If he can help it except in modest levels, but I I don't think it's anything more than across the board.
Yes.
Okay.
Great. Thank you.
Meta.
Your next question comes from the line of David <unk> with UBS.
Great. Thank you for taking my question.
A competitor just recently noted as you guys are talking about that they're seeing some orders placed a little bit earlier, suggesting that theres been a little bit of a pull of pull forward given sort of the industry constraints can you guys just kind of explain a little bit how you're thinking about visibility relative to your order book and backlog given the strength this quarter and sort of the supply constraints.
This should lead to.
Better visibility obviously over the next let's call. It 2 to 3 months and what does it mean for the fourth quarter without getting into specific guidance. Thank you.
Sure David M well as you know, we've always had limited visibility, but the last 2 quarters I've noted that our visibility has gone up due to our lead times. So I think there's a direct proportion to long lead times longer slightly longer visibility, so, particularly with the cloud Titans that actually works closely with we have been able to get visibility beyond.
On the 1 to 2 quarters that we normally get and we do have visibility into 2022.
And I think that's directly tied to them planning better and realizing that the longer lead times, they need to know what they're going to do in 'twenty 'twenty 2 for us to supply product actually want to add some more to that does just free all I'll say, we're not seeing on.
To put in sort of customer of doing it they won't tell us it's much more of the non binding demand signals of good is aware.
The discussions have been with customers, that's how we get our visibility from them.
It's just prudent planning David from a customer great no. That's helpful. I appreciate it thank you very much.
Yeah.
Your next question comes from Amit <unk>.
With Evercore ISI.
Good afternoon, Thanks for taking my question.
My questions really around the 400 gig opportunity and I think in the last couple of years, you've spent a lot of time explaining to folks how you of software stack is really differentiated against white box rates low.
To get your perspective of the underlying cause of loves it gets more complicated for.
400 gig in each of the gig what's the potential for cloud Titans debt has historically relied more on white box to start talking to Arista lots of them that you're seeing of shifting customers that have skewed more white box and always build their own product now looking to perhaps Bob.
Sure.
The company is that visit on white boxes of fairly sophisticated so they are not short on talent.
They are committed to of mentioned they would go ahead with it so I don't believe they have been.
Any changes happening in the industry to be simply because the of Nextgen is harder to boot.
But it's much more of other collaboration we have with them on the co development partnerships, we have new.
And we've talked about of the boats nothing has changed on the frontier of moving along on our ambition and the fear of situations, where a customer considered from buying from New York hooked on that book.
Of your used to actually materialize.
No Big change there expected I mean, I think the way to think of this is if you want commodity of hundred gig with all of our software stack and you just want to buy basic Manila stuff. They don't they will continue but if you really appreciate our collaboration on engineering innovation on our software stack.
And that's kind of Arista gets chosen.
Okay.
Perfect. Thank you.
Thanks, Amit.
Your next question comes from the line of Aaron Rakers with Wells Fargo.
Yes, Thanks for taking my question and congratulations on the quarter I wanted to actually ask about the progression of the subscription business within the model as we look at the services line is there any way or how are we investors should start to think about that as being an increasingly visible growth driver for the company. Thank you.
Thanks, Erin Thank you for the wishes wish.
We wish we could ship more.
I think the relationship to think of subscription as a long term indicator of you know not not necessarily just revenue, but the stickiness of our business right. When you look at cloud vision cloud of U S. A what we're doing we're neck of detection and response with AI, driven security or big fish acquisition the dance.
Monitoring fabric. These are all if you will layer of icing on the cake and Andy I think contributes good margin and obviously has a long term 1 year or 2 year of 3 of subscription. So the revenue shows up a little bit later, but the bookings are very strong because you can imagine from that so or we will continue to see strong sales.
Where service renewals as well from my acre and so the 2 together. We believe we've always said will be of 20 to 25 per cent contributor to the business.
Your next question comes from the line of Cemig Chatterji with J P. Morgan.
Hi, good afternoon, Thanks for taking my question.
You did come in starting off that you're seeing strong demand from enterprise customers.
Wondering if you can just talk about what you're seeing from the cost of all verticals like is demand actually moving similarly.
Similarly for example of the cloud Titans.
As some of the telcos and keeping that backdrop in mind does look like the third quarter guidance is for like a full force an increase when traditionally we've seen leg of high single digit so should I, just didnt flow thats, all supply kind of driven.
In terms of the moderation.
Quint.
Oh, well first of all thank you historically, a historical decided I think all of 4 or 5 verticals are doing well.
In that I would highlight cloud Titans and enterprise of stronger, but that doesn't take away from the contribution and success, we're having with specialty cloud financials or.
The service providers I guess, it's a case of a rising tides raise of everything so all of them are contributing well relative to our Q3 demand is strong and I wish we could ship more.
But I wouldn't compare it necessarily to our last Q3 in the post pandemic era I would just say on on the basis of large numbers of doing well.
Yeah, I think if you look at last year I mean, you know given the year that it was you saw a very significant uptick in Q3 was up 12% or something quarter over quarter that was just more of a semblance of what was happening of COVID-19 at the time right and previously I was wanted to like that yeah. I think the Q3 guidance of 2021 per cent of the midpoint year over year and that's a good place to start right now.
[laughter].
Thank you.
Thanks that makes the question.
Your next question comes from the line of of hard in the gym with M partners.
Well. Thank you for taking my question.
In terms of the pricing environment can you comment on are you planning on kind of passing on any of the incremental cost that you'll experience and can you also talk about the dynamic you were thinking of the market in terms of pricing of yours.
Competitors, increasing their pricing as well.
They're using this as an opportunity to kind of absorb the cost of maybe kind of aggressively price. So maybe a comment there.
We appreciate lots of hard I'm not in a position to talk about competitors, maybe they'll share that with you on this.
With us.
But I will say that we're gonna try our best to absorb the cost on selective models. We will have 2 where the increases are significant increased.
Increased prices slightly but we don't expect the impact on that on our backlog our existing inventory. So the real impact of any changes we make.
Our gross margin or our price changes next year.
I appreciate the response.
Thank you.
Your next question comes from the line of Jeff <unk> with 1.
Off research.
Yes.
Thanks, very much I M. Wondering you started to talk a little bit about deceleration in the back half of the year, which makes complete sense I'm wondering if there are any.
1 time.
Tailwind that you were expecting.
This year that we should be considering when you start to think about the shape of 2022, obviously you all don't want to talk too much about it but anything that we should be considering as we as we have to think about it.
Yeah, I mean, I think it is a it's a little early to start getting too specific about 2022.
This year did have an unusual so 2 of just because of the pandemic and how 2020 played out right. We're putting up some very good numbers now this year and that's obviously setting a good base.
For us to grow off next year, so bear that in mind, but on.
The business is solid and strong demand I think we're executing well on its broader right it's across the verticals.
We'll probably take a shot of giving you some of them you know some book ends and next quarter for 2022, but it's just a little too early yet.
Okay. Thank you Peter.
Thanks, Jeff.
A nice job of onshore Chris on the whole team for creating demand. So thanks Richard.
Yes.
Your next question comes from the line of Paul Silverstein with Cowen.
So just a clarification of course of district. George are you were you to say that you are expecting 20% growth now for top line for the year.
No.
Actually I would never say those things Paul but you know what did you think about the midpoint of the of the guidance for on Q.
Q3 year over year growth.
When we asked the willingness of of course as of last quarter. I think you responded in response to a question you said for this year, you're definitely expecting 15% growth for the year, but also on the Q&A.
Thoughts from what Youre expecting now for the year and can you also comment on how much the supply chain of costs in year on the revenue.
And in margin structure.
Yeah, I mean, I think for the year now when you layer in Q3, and you think about Q4, you can probably get to a reasonable view here I don't know that we wanted to put a specific number but you can get there once we give you the Q3 number on it.
Becomes a lot easier in terms of how much yeah. Clearly lead times are very extended right. It's always hard to kind of compare that to some kind of normal world. We could obviously do more revenue if lead times of weren't that extended how much it's really hard to put a number on I don't think we're going to try to put a number on that.
Alright, given that response can I ask you, we didnt cloud sorry since the <unk>.
<unk> been highly concentrated in Microsoft and Facebook, but of more recent vintage of crude you're having some more success with some of the other folks of the Google in particular any insight you can share with us.
I think Paul you summarized it very well on onshore on the team on doing a great job and booked a of.
Diversification across all our sectors and and while our Microsoft and Facebook on very strategic very important customers. We have other contacting customers also.
Next question please.
Your next question comes from the line of Sami Badri with credit Suisse.
Hi, Thank you.
A little bit just a clarification on just eat is common share regarding the second half consolidation now.
Was hoping you could give us some sequential guidance is there any potential of that sequential growth.
Be negative in <unk>, and <unk> and you know if I, just extrapolate out and I M.
Our forecast of a little bit out of from where we are today and even though it above we're getting into the low 20% range I just wanted to clarify if there would be any sequential decline in 2021.
Yes, I mean, we've given you Q3 right at the midpoint and that's clear any.
Growth there quarter over quarter, Yeah, again, we're not trying to guide too far of a Q4 is usually a good you know of.
Good strong quarter so I'll.
I'll leave you to draw your own conclusions from that but I think we've pretty much laid it out for the year semi I think the message we'd really like to convey is demand is strong we're doing well.
To execute on our shipments and we can only approach this our shipments 1 quarter at a time because of supply chain of so constrained.
Yeah.
Got it thank you.
Thank you.
Your next question comes from the line of Rod Hall with Goldman Sachs.
Yeah, Hi, Thanks for the question I guess I wanted to ask you about the gross margin guidance.
When we were talking to Cisco on a similar note they had said that.
The supply of the impact on their gross margins was bottoming or on their margins as bottoming of their guidance and I'm curious whether this guide for September from your point of view as kind of the bottom in other words.
Gross margins at least go sideways from there or do you think it's sort of an unknown at this point and you know things can could continue to worsen. So that's my first question that of a follow up.
Yeah, I think Rod you know on the ply chain stuff I mean, we did have some significant supply chain impact even in Q2 right. It just was more than offset by the customer mix right. So I think as we look forward I mean, we are paying more for certain components et cetera, then than normal and that that cost will get recognized.
Whenever we shipped those components from the products that are in those those components are incorporated into and so we will see some drag on gross margin probably for some time just given the inventory purchase commitment levels that we have.
We are that mix of help here of the enterprise mix is helping to offset that but customer mix is still by far the biggest driver. So we have a quarter, where there's a heavy cloud mix you are going to see.
Pressure on that gross margin.
Number for the quarter, but I think over time, we feel like we can we can stay in that 63 to 65 per cent range and that's a good safe kind of place to be.
But I guess, what I'm thinking of it as you're already kind of signaling some pressure on 64.
In the next quarter, because that's down over a per cent from this quarter.
And I'm wondering do you. So when you say that do you think it's part of it's probable that you have a materially lower margin of 64 or do you think when you say drag do you mean 64, just you know is a possibility for longer.
Yeah, No again, I think the biggest driver will be the customer makes on a quarter, where there's heavy customer mix that you could be back on 64 of you could even be below that right.
But again it'll be because of a particular mix on a particular corner right. So I think the range of still very valid.
On the 50 to plot the 65 plus that we saw this quarter is you know, it's a really good solid enterprise mix.
That's helping to offset some stuff. So you will see I mean gross margin is going to move around a bit over time, but I think we're still very comfortable in that range.
As of yesterday.
I think I said, a lot of our inventory costs will.
Will be realized later and this year on next year. So the gross margin would actually be more pressured when those higher costs of realized and so then if we have a really good enterprise mix, we could be on the better side of 62 to 65, if we have of high cloud mix, then I don't rule out the possibility of being on the lower side of 63.
It is 65 right recognizing that the cost of risk.
Yeah.
It's really going to enter that nobody is predicting the semiconductor supply cost of shortages are going away in 2022.
No definitely not.
And then that leads me to the enterprise trajectory, we see enterprise spending indicators are very strong here as we look at end of second half just curious what's your thoughts on the enterprise pipeline or I mean does that.
Look equally strong in your pipeline or how does that how does that look to you.
Yeah, Rod I think you've run out of questions, but the short answer is yes.
Okay. Thanks appreciate it thanks sure. Thank.
Thank you Rob.
Your next question comes from the line of Jason Ader with William Blair.
Yeah, Hi, guys. My question is.
4 of G suite.
The supply chain situation compare.
Prior periods in your career, where you've seen supply constraints.
Well I'm glad you're asking the the oldest person here.
Close to the oldest.
In my career of several decades I've never seen it would be this bad never this is the worst I've seen it.
And there's been some pretty big ups and downs, so and more than the worst of of ever seen it I think it's also going to be prolonged I guess, we're all hopeful we'd all of them recover from the Covid pandemic, but everything from copper shortages to wafer starts assembly to manpower of people logistics freight you know just about.
Aspect of it is challenged to do so on she'll do you want to add anything more to that as of yet.
On here.
[laughter].
As you said things are very constrained, but I think what's happened is the wood supply chain. They were planned for this big of a mismatch of supply and demand.
And as a result, when you run into a crunch people tried to book ahead of plan to rebuild buffer and so on.
This is not on industrial you can react in 1 part of the.
As of last a long time of the semiconductor industry of predicting maybe the coffee and plenty of 'twenty, 3 but who knows what a global demand will be at that time.
And it's on.
Prepared for a longer run.
And is it inevitable that at some point, we're going to see like a demand air pockets of Sri just because.
Everyone will have orders.
From what they needed ahead of time and it will hit some type of air pocket.
I don't know the answer to that Jason, but I think.
Given the business diversification we have.
The the planning on 1 type of customer will not affect the planning of others. So I'm, hoping that some of them of planning for 2022, and some of planning ahead, and 2023 and so the ex air pockets of balance off if you will.
Visibility, Jason I think to what the demand is for and when it'll get deployed at least of the larger customers is pretty good so that helps right it's not on.
Youre not youre deploying over time, that's right because its very much of EDA says of land and expand situation you don't just land and then buy nothing from a long time.
Very good thank you.
Thank you.
Your next question comes from the line of Jim Suva with Citigroup investment.
Thank you and I only have 1 question and that's related to your on our strength in revenues that you've just seen in kind of the outlook that strength is it being driven across all your end markets or are there kind of on 1 or 2 that you really want to call out to US is if you were to look back say.
6 or 9 months ago, you would not have guessed it would have been so strong because you really of posted really impressive results and of great outlook. Thank you.
Thank you, Jim and again, a lot of credit goes to our onshore and his teams. So I am actually I would love for you to answer this question, but let me just preface it by saying all 5 verticals of very strong they're all growing double digits.
And in fact, I feel bad reading any of them are second or third or fourth of this place, but if you ask me what I'm most positively surprised by you might remember a year ago, Jimmy we're less bullish on the cloud Titans, we thought there'd be even be flat to down so actually you want to add to that share.
What a difference of Youll make so despite the COVID-19 impacts, but the cloud Titans sort on a strong upgrade cycle with 400 gig on.
Planning the transition of not just 400, but the mix of 100 to 100.400.
And the customers of sense of surprised at the end of August so strong for their businesses. So that's been a good upside for us on.
Statements to plan to price they talked about enterprise for quite some time.
We're quite happy with the adoption by our customers.
Our primary of data center market, but also expanding into campus into monitoring into security.
We have a long way to go it's a very long time, and we're just getting started there so that keeps us very positive on both of their theaters.
Thank you and congratulations.
Thank you Jim.
Your next question comes from the line of Simon Leopold with Raymond James.
Thanks for taking the question at the beginning of July the U S government announced the cancellation of the Jedi project with a plan to put it out for rebid.
I'm just wondering how you would factor that into your own forecasting and modeling given that you sell into.
1 of they essentially participants on that project does this change your thoughts on this year and longer term what do you do in terms of of project when it comes to forecast on your overall business. Thanks.
Thanks, Simon I don't think we really factored it in very much except making sure we had all of the certifications.
You want to add to that in more on some of this was a contract of what 10 years.
It's not as of we saw any significant change on the loss share related to that.
Edition of the contract.
Data of program might be gone, but there's so many other programs of the government is doing with various cloud companies. So.
It's mixed into the noise, we don't really see the big upside I don't think there's anything don't hurt either.
How big is government typically for you.
No.
Is this wasn't going to say this is going through 1 of our cloud customers, which is why we don't see it not really government of its cloud Titan.
Yeah, no, but I guess in general because government sounds like a good vertical I don't know that you've talked about it in the past no. We haven't we could do a lot better.
The government is not big for us, but it's mixed into our enterprise momentum. It has improved year over year, but in terms of any kind of contribution of large concentration we were long ways to go.
Next question. Thanks Simon.
Your next question comes from the line of Tal Leone with Bank of America.
Hi, guys I'm trying to ask a question without asking it directly so.
Looking for a big win with 1 of the cloud Titans.
On this question I have is what's your outlook for cloud Titans are there big kind of wins are big announcements in the pipeline that youre looking for is there any.
Anything you can share with us about.
The puts and takes what could happen with cloud Titans over the next few quarters. Thanks.
True.
I'll touch on very happy with the results so far and there's no more upside expected.
We're doing well with our customer of execution has been good on it is a competitive market on display the country of do very well with both our hardware design on supply of product on especially on software.
No Big change I mentioned this loss share as well.
We are maintaining the status quo in terms of customers of the customers grow we grow with them. We obviously don't control of that aspect on con focused on their behalf, but otherwise it's more.
Moving on the mixture of architecture with these entities and what did you think of them as cloud Titan internally, we think of each 1 of the market rate.
So from a complexity, but no theres no big announcements, they're making or about to make all of hill.
There's so many key milestones that need to be achieved before that can be done on anything that's dramatic of a big shift.
Can you if I can squeeze in another 1 if not it's okay can you talk about the contribution of cloud Titans to this quarter and also last quarter results I'm trying to understand how important is it in relative terms how important is it to the overall growth.
Oh, it's so we decided to go annually rather than quarterly call, but its staying within the annual targets. We gave I believe you said it was 34% to 39.
So that that that's the contribution from cloud Titans, 34% to 39%.
What about the growth.
How much of the growth is it is it proportionally much higher than the 35% to 39% of the growth.
And no we don't comment on it's very hard to look at it on a corner by corner of it cloud and it and cloud contribution to growth is always going to be important enterprises, becoming more important right, but I don't think we want to try and do it on a corner, but yeah. I think I think it would make more sense of annually Todd because of the so constrained by shipments right. So it would be of false signals on if we said it was high low.
All of our medium.
I think on an annual basis, it's a much better number and the growth would be good they'll definitely be double digits build.
On the number 1 vertical and it's important for short on anybody think of and it's not.
An important part of the mix. Thank you Tal I think of.
We are ready for the next question. Thank you your.
Your next question comes from the line of John Marshall <unk> with Stifel.
Yeah.
I was wondering if you could just kind of mid or 2 just talking about what youre seeing specifically in that 400 gig market. Obviously, we'd go back to the early part of the year and it seemed like we were pumping the brakes of little bit on on expectations that seem to change a little bit last quarter, you seemed a little bit more bullish there just curious if you could spend a little bit of time and I'm assuming that is.
Still primarily of cloud Titan market, but just anything you're seeing there would be helpful.
Well, it's actually more than cloud Titans I think of Arista has been Trialing 204 hundred gig since Q4.2019, if I remember when Andy was here and we talked about the whole portfolio of products. So this combination of 10 to knock on.
Hundreds of 200.400.
We expect to see a significant increase.
Just to give you some context here, we had about 75 customers last year.
And we expect that to triple to quadruple this here and customers. So it's way more than the cloud Titans.
Yeah.
Great.
And your next question comes from the line of Ben Bollin with Cleveland Research Company.
Yeah.
Good afternoon, and thank you for taking the question.
Jason you talked a little bit about getting some additional visibility from hyperscale partners versus history, even into next year.
With that perspective could you talk about how you see the evolution of 200.400 as they roll that out of that develops and maybe how you think of comparison with what you saw with 100 in terms of I don't know the pace or speed of adoption.
Yeah, No. That's a really good question I kind of 100 gig pace on adoption was remarkably fast it was probably over an 18 months period on she'll correct me if I'm wrong 2016 to 18, something like that right that the 200.400 gig has been more gradual and very very many use cases, it's coupled with.
100 gig so I'll try so hard for us to separate out and we I think I've. Finally at this inflection point of a pivot point, where we expect to see more 200 gig on 400 gig shipments in our cloud Titan customer base in the second half of this year and I think this will continue on will be vibrant for at least 3.
3 years to come maybe longer you on is there a long tail to that are actually moving onto.
Ben I think it's important to note debt when the world point of 100 gig of in 2016.2017 on.
<unk> was pretty much comparable backward compatible with 40 gig.
Cost of CMS 40 gig.
The same power consumption of 40 gig, who doesn't know Brent fell brain I am upgrade 204 hundred gig of another theme the companies that are going to of the ones who absolutely need it.
Other technologies and more like the ZR optics needed for data center interconnect on.
What sort of constraints loss share and audio of this sort of quote.
So this is 1 of this adoption curve is very different on it's not of every layer of the networks and I would not model that on the 2016 points of 2017 cycle. These are different upgrade cycles.
Which is why you have to come back towards tissue of clean.
Of the combined 100 to 100.400, new everything on a lot of 100 gig to the new next gen products as well on <unk>.
Very much material on matters, what 1 of the addition of I'd like to make on the non cloud Titans side. Ben I know you are more focused on that is many times day make sure. They buy a product thats for 204 hundred or even 800 gig capable, but they'll deploy on new 100 gig.
So what is clearly happening now as customers are getting ready for the highest speeds and dependent on how they deploy them and timing.
That's great. Thank you.
Thanks for the Internet you're.
Your next question comes from the line of John Lopez with vertical group.
Hey, thanks very much.
I believe you said in calendar Q1, you grew product deferred by about 40 million or sort of sequentially and I thought I heard you say its another 20 million or so this quarter.
I guess the 2 questions I had there 1 do you ascribe any of that to component constraints or is that all product feature sets and then secondly, do you expect that to flow into the income statement in the second half of this year or is that stuff, you'll carry with you into 2022.
Yeah. So it's not really related to the supply side stock, it's more about new customers new use cases of new products right that that's what drives that number.
It is kind of.
Even in Q2, if you look at it as you know some of that stuff was recognized and then we added other new stuff. So there is kind of some churn underneath as that of that balance right, but I don't expect us to take any revenue net revenue. If you like out of that bucket in Q3, and we'll see what happens in Q4, that's a bit farther out, but I think given the.
The comments from the script around how that balance filled I.
I think we've got lots of new stuff happening. So I think it's probably unlikely that we would be depleting that balance.
This year.
Thank you.
Your next question comes from the line of Alex Henderson with Needham.
Great. Thanks.
Was hoping you could talk a little bit about.
The environment in terms of pricing we've heard from some players in the market that Cisco is talking about 5% to 10% price increases on.
Variety of products, including switching and routing.
<unk> products.
And passing through more of price increases and what you alluded to you. Obviously suggested that you are going to be relatively.
Careful with that.
Push through a lot of pricing on your customers.
Is there of Delta.
Developing there.
Within that context could you talk a little bit about the.
The strategic approach.
<unk> trying to bundle together the <unk>.
Some of the Acacia products and whether that architectural change to a.
Switch routed the optical platform.
Something of that you concur with which you think is the pools earned.
Wow that was a loaded question, so I'm going to break it into 2 on should think about the Acacia Y on Y like discuss the delta on pricing, it's difficult for us to parse our competitors' pricing, but I can tell you philosophically you know we got backlog, we got products in flight and we've got customers, who are making their budget plan.
On to try as much as we can in the short term to absorb the cost that said, we will have some slight price increases probably in the range of 5% on selective models that will affect our customer base in the tail end of this year of next year.
And it does it still effect on gross margins if that if the if the mix changes dramatically to cloud Titans says it is allowed to alluded to so all of this to say Alex to they're going to be very thoughtful because you know its pain for us and moving to try and mitigate the pain for customers and only apply it where there's a real shortage and a real significant cost income.
Yeah.
And actually you want to take be a case of your question.
Alex the way our customers buy ZR optics and as you know we've been involved in these architecture since the 2016.2017 timeframe you'd per 100 gig 100 kilometers of optics.
A lot of companies, especially low dose of the nineties on early proposals do not like bundled solutions they'd like to disaggregate. The disaggregate. It we live not just white boxes.
The uptake on those switches are not allowed to be built on a bundle of pivotal trial.
On a separate RFP for each 1 of <unk>.
You have to be independently competitive at each glu to win which is why this is not of concern of nerves, we mentioned opex of lost them.
On other companies can participate we don't have to we have all worked out and we try to qualify as many optics vendors. So at any given time now you have of team on true that's qualifying the number of vendors right.
I picked out alternative quantified it yeah I have noticed is.
There is a lead time on your qualification do I understand you think of.
Good luck.
Thank you Alex next question.
Your next question comes from the line of James Fish with Piper Sandler.
Hey, Thanks for squeezing me in here and I was going to comment before that age is just a sign of wisdom. So I wouldn't say all but just was on without.
Thanks, Jamie.
I'll just can't let you an awful lot of that debate, whose wise is still offline.
Given that volume.
Got.
So you guys are starting to see some 5 G core spending or at least the industry as you know pick up and we even saw AT&T and Microsoft kind of announce something on the core carrier grew pretty nicely. It looks like if you use the midpoint of those ranges you gave those of relationship with Microsoft to help extend your reach into your carrier environment as they look to take.
Some of their core to the cloud or will it be more of a fulfillment b of support for agile is the way to think about it thanks guys.
Yeah, No I think in the short term, it's very much a relationship tied to azure, but theres nothing that precludes, particularly with their investments and <unk> and some of the recent acquisitions. We made it as you know service providers or a long term test of our patients, but when you win them you win them. So we are seeing our own per.
Moving to independent on Microsoft very much tied to upgrade 2.5 G where we are of the back of the core routing and platform and spine, but specific to Microsoft I think it'll take time, it'll probably emerge in the next several years today its primarily of sure.
Okay. We have time for thank you James 1 more question last but not least.
This question comes from the line of Kyle Mcnealy with Jefferies.
Hi, Thanks, a lot of for the question. This is Kyle on for George Notter.
Curious if there's any change to the mix of customers or ports using cloud of U S versus the traditional standard of U S funnel with of hardware sale.
Yeah, maybe still quite small, but any quantifiable color you can provide around what the mix might currently be and could that help your gross margin at all or makes you a little less sensitive to the supply chain issues that youre seeing in some areas.
Alright, thanks kind of kind of like how do you as an example of a very strategic software platform, but it's very very tiny in ports and it has more to do with a multi cloud hybrid networks strategy, where almost every 1 of these enterprise customers and also has some premise strategies. So I would say the strong influence of millions of ports is still on the.
On the mainstream platforms and cloud of U S is is on top of that.
On to connect into multi cloud.
Okay, Great. That's helpful. Thanks, Thanks so.
This concludes the Arista Q2, 2021earnings call. We have posted a presentation, which provides additional information on our fiscal results, which you can access on the investors section of our website. Thank you for joining us today.
Thank you for joining ladies and gentlemen. This concludes today's call you may now disconnect.
Okay.
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