Q3 2021 Arista Networks Inc Earnings Call

November 1, 2021

Welcome to the third quarter 2021, 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 given at that time. If at any time during the conference you need to reach an operator. Please press the star followed by zero.

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 Lynn Stein of Arista's director of Investor Relations you may begin.

Thank you operator, good afternoon, everyone and thank you for joining us.

With me on todays call are Jayshree Ullal Arista Networks' President and Chief Executive Officer, and Eaa Brennan our Chief Financial Officer.

This afternoon Arista networks issued a press release announcing the results for its fiscal third quarter ending September 30th 2021.

If you would like a copy of the release you can access it online 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 fourth quarter of the 2021 fiscal year. Longer-term financial outlooks for 2022 and beyond.

Longer term financial outlooks for 2022 and beyond.

Our total addressable market and strategy for addressing these market opportunities, the potential impact of COVID-19 on our business. Product innovation, the impact of supply shortages and manufacturing constraints on our business, including lead times and inventory purchases 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.

Product innovation, the imply of supply the impact of supply shortages and manufacturing constraints on our business, including lead times and inventory purchases 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.

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.

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 Jay Shri.

Thank you, Liz, and welcome to your first earnings experience. Thank you everyone for joining us this afternoon for our third quarter 2021 earnings call. Today's call will be followed by a virtual analyst day at three PM Pacific standard time.

We delivered record revenues of $748.7 million for the quarter with record non-GAAP earnings per share of $2.96. Care services and software renewables contributed approximately 21,5%. Our non-GAAP gross margins at 64.9% was influenced by enterprise and cloud Titan momentum.

Care services and software renewables contributed approximately 21, 5%.

Non-GAAP gross margins at 64, 9% was influenced by enterprise and cloud Titan momentum.

We remain pleased with our healthy customer growth, including record millions of customers and new customer logos in our mainstream enterprise.

In Q3, 2021 Cloud Titans was once again, our top vertical with enterprise being a close second followed by financials and speciality cloud providers tied to third and service providers at fourth place.

All verticals contributed to a risk of diversity and growth. International contribution was strong at 25% with the Americas at 75% for the quarter.

International contribution was strong at 25% with the Americas at 75% for the quarter.

No earnings calls these days is complete without supply chain commentary, we are clearly in the midst of an acute supply chain crisis with increased prices and long lead time.

We are changing our Arista mindset for my historical build to forecast and orders to built to invest, doubling our purchase commitments in excess of $2 billion and planning for the next one to two years.

Lead times of many components of extended to 50 to 80 weeks with price hikes, ranging from 15% to as high as 200% across our entire supply chain of copper, steel, substrate, printed circuit board, memory, Silicon, ASICs connectors freight and labor.

However, there has been deliberate and thoughtful about price increases so far as we've shared with you, but we have recently announced the increased list prices effective November 4th 2021, averaging about an approximately 10% to offset these very high escalating costs.

Customer demand remained strong for Arista products as we're gaining market share in 100, 200 and 400 gig high performance switching according to market analysts.

We truly appreciate our customers and partners for their patience and understanding as we navigate these turbulent times throughout 2022 as well.

Recently, we have witnessed the progress of our routing products with key customers and the acceptance of our routing edge use cases. Similar to Cloud Titan carriers and large enterprise customers I did driving immense benefit from Arista EOS and rich routing features. We deliver simplification and unified service delivery with the support of segment routing with traffic engineering and EVPN as well as rapid failover techniques.

Delivery with the support of segment routing with traffic engineering and E V. P N as well as rapid fail over techniques.

This provides that ideal alternative to today's complex legacy router deployments with much more improved total cost of ownership and CapEx benefits.

Since its founding, Arista has pioneered the transformation from routers to routing without leaf-spine our series platforms. Arista third generation R3 series based on EOS Florida twenty-six delivered three new edge use cases this year. The first one is a multi cloud edge that brings provisioning and programmatic traffic steering.

The second is the metro edge for single protocol adoption across multiple edge VPN services into the Metro Ethernet fabric. And the final escape is a 5G ran edge, where the 5D Edge is disaggregated the radio area network with scale out routing.

Continuing our theme of Big bet wins, I would like to highlight worldwide examples of our strength with specific customer names in routing and campus adjacencies.

The first customer of our city line and international service provider in Italy that adopted Arista for their routing transformation.

Arista solution get let them to take a fresh approach to routing for next generation edge and backbone, reducing the complexity of protocols. This deliver an L Two and L. Three services with EVPN on a segment routing backbone, along with modern operations and superior services and experience.

Our second customer was Connecticut education network, who standardized on Arista as R series with Arista EOS being instrumental in the transformation of the Mpls VPN edge, providing hundred good density Internet rough scale stability and manageability.

The advantages from the relationship with CEN across service and engineering affirmed their decision to choose us at Arista peering between ISPS using 100 gig in PES to replace the large legacy routers.

Third customer [Ozanne Leer] an international customer in Asia Pacific, who is delighted to partner with Arista and build a next-generation cloud edge and routed backbone for the infrastructure growth. Arista's rich routing stack brought programmatic traffic engineering and the core of the segment routing without sacrificing quality performance and reliability.

And finally in the campus, we continue to make progress towards our goal of doubling to $200 million in the cognitive campus in 2021. An example of this is an international customer win in Australia, the Australian Securities Exchange, providing cognitive campus for its corporate sites in Sydney, Melbourne, and Perth.

The new campus network is based on the risk as why it platforms to 720 XP series and it's built on a multiyear relationship rebuilt between Arista and effects utilizing EOS and cloud vision for real-time insights across all devices and trading and non-trading environment.

In summary, our risks discussed the most strongly endorse our client to cloud strategy to unify silo datasets consistently we believe we are well-positioned for the next phase of growth in data-driven cloud networking with proactive platforms, predictive operations and a prescriptive experience, we look forward to sharing more of this and our vision and our goals with you at our Analyst Day. Later this afternoon I will pass it over now to Ita Brennan, our chief financial officer for financial specifics.

And our vision and our goals with you at our Analyst Day. Later this afternoon I will pass it over now to either Brennan, our chief financial officer for financials specifics.

Thanks, and good afternoon. This analysis of our Q3 results and our guidance for Q4 '21 is based on non-GAAP and excludes all noncash stock-based compensation impacts certain acquisition-related charges and other nonrecurring items.

A reconciliation of our selected GAAP to non-GAAP results is provided in our earnings release. Total revenues in Q3 were $748.7 million up 23.7% year over year and above the upper end of our guidance of $725 million to $745 million.

Total revenues in Q3 were $748 7 million up 23, 7% year over year and above the upper end of our guidance of $725 million to $745 million.

Shipments remained constrained in the period as we continued to carefully navigate industry wide supply chain shortages and COVID-19 related disruptions.

Services and subscription software contributed approximately 21.5% of revenue in the third quarter down from 22.3% in Q2. International revenues for the quarter came in at $191 million or 25% of total revenue down from 27% in the second quarter.

International revenues for the quarter came in at $191 million or 25% of total revenue down from 27% in the second quarter.

This shift in geographical mix on a quarter over quarter basis reflects a continued healthy performance from our cloud Titan and in region businesses in EMEA with some volatility in our APAC business.

A continued healthy performance from our cloud Titan and in region businesses in EMEA with some volatility in our APAC business.

Overall gross margin in Q3 was 64.9% at the upper end of our guidance range of approximately 63% to 65%. We continue to recognize some incremental supply chain costs in the period and these were offset by a healthy mix of revenue from our enterprise customers in the quarter.

Operating expenses for the quarter were $192.4 million or 25.7% of revenue, up from last quarter at $189.8 million. R&D spending came in at 125 million or 16.7% of revenue, up from last quarter at $119.6 million. This reflected increased headcount and employee-related costs and higher new product introduction spending in the period.

R&D spending came in at 125 million or 16.7% of revenue up from last quarter at $119 6 million.

This reflected increased head count and employee related costs and higher new product introduction spending in the period.

Sales and marketing expense was $55.8 million or 7.4% of revenue down from $57.9 million last quarter with lower demo and other variable expenses in the period. As a reminder, we continue to benefit from lower COVID-19 related travel and marketing expenses.

Our G&A costs came in at $11.6 million or 1.5% of revenue down slightly from last quarter, but in line with normal quarterly seasonality. Our operating income for the quarter was $293.7 million or 39.2% of revenue.

Our operating income for the quarter was $293 7 million or 39, 2% of revenue.

Other income and expense for the quarter was a favorable $1.3 million and our effective tax rate was approximately 19.7%. This resulted in net income for the quarter of $236.9 million or 31.6% of revenue.

This resulted in net income for the quarter, a $236 9 million or 31, 6% of revenue.

Our diluted share number was $79.9 million shares resulting in a diluted earnings per share number for the quarter of $2.96 off approximately 22.5% from the prior year.

Now turning to the balance sheet. Cash cash equivalents and investments ended the quarter at approximately $3.4 billion. We repurchased $134 million of our common stock during the third quarter at an average price of $357 per share.

We repurchased $134 million of our common stock during the third quarter at an average price of $357 per share.

As a recap at the end of Q3 2021, we have repurchased $897 million or $3.9 million shares against our board authorization to repurchase $1 billion worth of shares over three years beginning in April 2019.

In October 2021 Arista's board of directors increased the authorization by adding an additional $1 billion for the repurchase amount. The actual timing and amount of future repurchases will be dependent on market and business conditions, business requirements, stock price, acquisition opportunities and other factors.

The actual timing and amount of future repurchases will be dependent on market and business conditions business requirements stock price acquisition opportunities and other factors.

Now turning to the operating cash performance for the third quarter, we generated $273 million of cash from operations in the period. Reflecting strong net income performance and continued investments in inventory and supply chain. DSOS came in at 49 days up slightly from 47 in Q2, reflecting the linearity of billings in the period.

<unk> strong net income performance and continued investments in inventory and supply chain.

Dsos came in at 49 days up slightly from 47 in Q2, reflecting the linearity of billings in the period.

Inventory turns were 1.7 times consistent with last quarter inventory increased to $575.7 million in the quarter. Up from $543.2 million in the prior period. As we continued to buffer certain components products.

Up from $543 2 million in the prior period as we continued to buffer a certain components products.

Our purchase commitments number for the quarter increased to $2.1 billion up from $1.1 billion in Q2. This reflects the combination of increased lead times for many components and improved demand visibility.

This reflects the combination of increased lead times for many components and improved demand visibility.

We continue to prioritize newer early lifecycle products for inclusion in this strategy to help mitigate the risk of obsolescence. Our total deferred revenue balance was $800 million up from $746 million in Q2.

Our total deferred revenue balance was $800 million up from $746 million in Q2 the.

The majority of the deferred revenue balance is services related and directly linked to the timing in term of service contracts, which can vary on a quarter by quarter basis.

Approximately $113 million of the balance up from 90 million last quarter represents product deferred revenue largely related to acceptance clauses for new products. Most recently with our larger cloud Titan customers.

As a reminder, we're currently in a period of significant new product introductions combined with a healthy new customer acquisition rate and expanded use cases with existing customers.

These trends in conjunction with reduced levels of upfront in-person testing have resulted in increased customer-specific acceptance clauses and higher product deferred revenue amounts.

Accounts payable days were 47 days down from 54 days in Q2, reflecting the timing of inventory receipts and payments. Capital expenditures for the quarter were $45.9 million, including approximately 40 million of Capex related to the purchase of land to construct a new data center and hardware engineering building in Santa Clara. We will provide more details on this project over the coming quarters.

Capital expenditures for the quarter were $45 9 million, including approximately 40 million of Capex related to the purchase of land to construct a new data center and hardware engineering building in Santa Clara will provide more details on this project over coming quarters.

Now turning to our guidance for the fourth quarter and beyond. As outlined in our guidance we now expect to achieve year over year revenue growth for the full year 2021 of approximately 25%.

This reflects continued healthy demand across all market sectors tempered by the impact of a difficult supply environment.

On the gross margin front, industry supply constraints and elevated logistics costs continue to pressure gross margins with customer price increases as a potential offset.

Based on our current outlook, we continue to reiterate our overall gross margin outlook of 63% to 65% with customer mix remaining 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.

Finally, we also announced today that the rest of the board of Directors has approved a four for one stock split each risk to shareholder of record at the close of business on November 11th 2021, we received three additional shares for every share held. And trading will begin on a split-adjusted basis on November 18th 2021.

With all of this as a backdrop, our guidance for the fourth quarter, which is based on non-GAAP results and excludes any non-cash stock-based compensation impacts and other nonrecurring items is as follows. Revenues of approximately $775 million to $795 million, gross margins of 63% to 65% operating margin of approximately 37%.

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Our effective tax rate is expected to be approximately 2.5% with diluted shares on a pre-split basis of approximately 80 million shares. I'll now turn the call back to Liz. Liz. Thank you Ita, we are now going to move to the Q&A portion of the Arista earnings call.

I'll now turn the call back to Liz Liz. Thank you Nita, we are 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, operator take it away.

We will now begin the Q&A portion of the Arista's 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 press the pound key. We ask you to pick up your handset before asking questions in order to ensure optimal sound quality. First question comes from the line of [inaudible] with J P. Morgan.

Our 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 press the pound key.

You pick up your handset before asking questions in order to ensure optimal sound quality.

First question comes from the line.

Semi chatter G with J P. Morgan.

Hi. Thanks for taking my question. Congrats on the strong results. Really impressive so let me keep it broad. I think you mentioned strong demand that you're seeing and I think you highlighted Cloud customers in the press release, but just generally if you can talk to how broad-based is the demand that you're seeing across Cloud.

Congrats on the strong results.

Really impressive so.

Let me keep it broad.

I think you mentioned strong demand that you're seeing and I think you highlighted.

The press release, but just generally if you can talk to.

We used as the demand that you're seeing across.

Good.

Or what is the magnitude of demand that you're seeing from enterprise customers and then how do you think about sustainability. What you're seeing this year and how do we think about [inaudible] into next year? Thank you.

What you're seeing this year and how do we think.

That into next year. Thank you.

Sure well. Thank you for the good wishes, it's a proud moment. And I really congratulate my entire leadership team and my employees for getting us here.

And I really congratulate my entire leadership team and my employees for getting us here.

I think demand is very strong as I mentioned in my earlier script across all five verticals, across all three product lines. And across all three sectors as well. So I would tell you when we are growing in that, what Ita highlighted as a 25% annual growth every sector is growing.

E to highlight it as a 25% annual growth every sector is growing.

And so that's in some ways I feel bad that I even have to rank and ranked them, but if you asked me to highlight some of the growth vectors I would say, obviously cloud Titans are back.

Well if you remember two years ago Halloween was not a treated was a trick. And it's just come back and it is a volatile sector and it's positively volatile right now. So we're enjoying the growth of Cloud Titans. We're also enjoying many pieces of our enterprise market growing and I really sub-verticals there that are doing very very well not just the financials, but different parts of the enterprise. I think it's fair to say Arista has arrived in the enterprise, we've been growing double digits for a couple of years and we expect to continue to see double-digit growth in the enterprise sector and this is by far our largest momentum of all the verticals I would say.

And.

It's it's just come back and it is a volatile sector and it's positively volatile right now so we're enjoying the growth of cloud Titans. We're also enjoying many pieces of our enterprise market growing and I really sub verticals. There that are doing very very well not just the financials, but different parts of the enterprise I think it's fair to say Arista has.

arrived in the enterprise, we've been growing double digits for a couple of years and we expect to continue to see double-digit growth in the enterprise sector and this is by far our largest momentum of all the verticals I would say.

But not as I mentioned a lot of routing use cases. These routing use cases are not only in the cloud Titans, but obviously also in service providers and enterprises as well. So we're just enjoying a very diversified momentum of our business at the moment. Thank you. Thank you.

Thank you. Thank you.

Your next question comes from the line of Fahad Najam with MKM Partners.

Thank you for taking my question. I wanted to ask you a question on visibility. You mentioned that sort of components have [many kinds of different times] from 50 weeks to 80 weeks. I presume your customers are giving you forward-looking guidance as well. So can you give us a sense of the visibility you're seeing and help us quantify that? In any way you can.

I wanted to ask your question.

You mentioned that sort of components.

It's critical 50 weeks Adv I presume your customers.

We're giving you.

Looking guidance as well.

So can you give us a sense of the visibility you have.

Can you help us quantify that.

Any way you can.

Sure I'll say a few words and Ita if you could add to that. I think because of these kind of long lead times on all components first thing that he and the team are doing onshore and the entire team are planning ahead, and we're no more like we said building to forecast our orders, but really building to a future demand so visibility becomes very important in that case.

Because it's no more one or two quarters. The Cloud tightness visibility has improved a lot. This year typically it used to be one to two quarters right now, it's more like a year or more.

So this is the best visibility we've ever had with the Cloud Titans, that's allowing us to build up inventory and to build a plan to get ahead if you will. In the enterprise as well Nobody's lead times are very good right now and we're no different, although we thought and we believe we have a head start by starting on this problem as early as last year.

And you know we have several hundreds of suppliers and we've had to increase our strategic interface with these suppliers to and unmake again bets on them long term.

Interface with these suppliers to and unmake again bets on them long term.

So within the enterprises also six months to a year visibility into cloud and specialty cloud providers is now exceeding a year. So in general we're now able to make a plan to buy components well ahead of the purchase orders and forecast.

Exceeding a year. So in general we're now able to make a plan to buy components well ahead of the purchase orders and forecast.

You want to add something more? Yeah, I mean, I think the only thing I'd add to that is that it's hard to be too quantitative when you think about demand and bookings just because obviously the lead times and the Timeframes are very different right. So I think from just from a business perspective, we'll continue to focus on the revenue and the revenue metrics and then the bookings numbers will kind of ebb and flow, but obviously right now you.

We are getting a lot of visibility to what's happening with customers, just because we need that to be able to drive the types of purchase commitments et cetera, we're driving.

I appreciate the answer.

Thanks Scott.

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

Yeah. Thanks for the question. I'd like to echo the positive comments. These are phenomenal results in this environment.

To echo the positive comments. These are phenomenal results in this environment.

I guess my question is regarding the Cogs and the cost of some of the products you are getting from Broadcom. Other companies we've talked to during this earnings season talked about really high expedite fees.

Really high expedite fees.

And just wondering if you're seeing those and how they are factoring into the forward cost in the business. Like are you able because of this visibility to set your prices at a level that compensate for what we see higher Cogs unwind maybe in the early part of next year? I'm just curious whether you're seeing those expedite fees and then how they might affect margins at some point.

Factoring into the forward cost in the business like are you able because of this visibility to set your prices at a level that compensate for what we see higher Cogs unwind maybe the early part of next year I'm, just curious whether you're seeing those expedite fees and then how they might affect margins at some point.

I think everybody is seeing and I'm talking about a particular supplier, but we are seeing expedite fees.

Talking about a particular supplier, but we are seeing expedite fees.

And incremental costs kind of across the supply base right. And you haven't seen those in the gross margins in the income statement today, just because the mix has been more enterprise heavy and that's been kind of offsetting that, right.

You know I think we are you know as Jayshree mentioned, we are in the process of instituting some price increases et cetera to help offset some of those costs. So that will help.

I think we're comfortable thinking about that 63% to 65% range is still being reasonable, but you will see some more volatility quarter by quarter, just as the mix of the business. The customer mix is still going to be the biggest driver.

The other costs, we're managing with some of the price increases et cetera. When we have a heavier cloud mix any particular corner et cetera, we will see some lower gross margins than what we've seen over the last couple of quarters.

When we have a heavier cloud mix any particular corner et cetera, we will see some lower gross margins than what we've seen over the last couple of quarters.

And thank you for the good wishes, Rod.

Sure. No problem, just a question of our customer and what about the cloud customers are they willing to accept a little bit of price increase knowing that things are getting more expensive? Just curious what the conversations are like there.

No problem, just a question of our customer and what about the cloud customers are they willing to accept a little bit of price increase knowing that things are getting more expensive just curious what the conversations are like there.

I would say all of our customers are very understanding, but nobody is willingly accepting price increases, including the rich cloud Titans.

Right. Okay. Thanks a lot.

Thanks Rod.

Yeah.

And your next question comes from the line of Jim Suva with Citigroup.

Thank you, truly spectacular and I got to just ask about the build to forecast versus build to order kind of when did you implement that and what was the reaction of some of your customers? Or was it a more internal and what I'm wondering is how much further are you may be ahead of some of your competitor.

It sounds like that's actually may be something that you're looking for for the next couple of years. If you have lead times going so long. Thank you.

Right. First of all I just want to give a big shout out to onshore John Nicols, Susan Hays and the entire manufacturing team.

First of all I, just want to give a big shout out to onshore John Nicols, Susan Hays and the entire manufacturing team if you'll let.

Let me just step back Jim and thank you for the kind wishes. The traditional model for everybody has been built a forecast lead times are based on supplier commits, there's some buffers, but most of it is just in time right. And very rarely does anybody pay for expedites. If you look at supply chain in 2022 first of all Expedites are a way of life it doesn't matter which vendor it is. You have to plan not just weeks ahead, but months ahead, often you can get decommit from supplier shortages across the board. There's lots of orders, there's no buffers. Everybody's coming at them, sometimes than we used to think the high tech industry special but some of the components we're talking about we compete with the automotive industry in that.

which vendor it is. You have to plan not just weeks ahead, but months ahead, often you can get decommit from supplier shortages across the board. There's lots of orders, there's no buffers. Everybody's coming at them, sometimes than we used to think the high tech industry special but some of the components we're talking about we compete with the automotive industry in that.

Consumer industry, which makes it tougher and it isn't surprising at all to see Expedites. It involves not just CEOs, but heads of countries literally that's how rough it is. So it's a very oversubscribed process. We thought we got a head start by starting when was it late last year when the onshore and the team put together a plan. So we've definitely had a head start.

It involves not just Ceos, but heads of countries literally that's how rough it is so it's a very oversubscribed process. We thought we got a head start by starting when was it late last year when the onshore and the team put together a plan. So we've definitely had a head start.

And if things had gotten better you know we would be well ahead of everyone, but things keep getting worse. So now the head start is good but we have to add to that head start and hence the doubling of the inventory and without naming any vendor I'll just say we have increased the strategic nature of our relationship with not just one or two vendors, but 25% of our vendors. So this is a much larger relationship pool, and we're committing to them long term they are committing to us.

<unk>, 5% of our vendors. So this is a much larger relationship pool, and we're committing to them long term they are committing to us.

Both of us have to be patient and understanding of the short term troubles we have.

Thank you and again really big congratulations to you and your entire entity. Thank you.

Thank you they kudos to my team.

Your next question comes from that line of Paul Silverstein with Cowen.

Thanks for taking the questions. Two related questions if I may. Was is really 200 gig from Facebook and any 400 gig revenue from Microsoft in your third quarter? And do you expect in the fourth quarter in Suzhou would you care to talk a little bit outlook for next year? I know supply chain is challenging.

202.

Facebook and any 400 gig revenue from Microsoft in your third quarter and do you expect in the fourth quarter in Suzhou would you care to talk a little bit outlook for next year.

I know our supply chain.

And it's challenging.

Yeah.

I'm just checking to see but there was 400 gig revenue overall as I told you last time. We have increased our customer logos in the 400 gig category from 75 customers last year to the first half was 150, and we're trending to about 300 customers. So there's definitely 400 gig I need to double-check on whether there was any 200 kg, let me beg off that question either.

We have increased.

Increased our customer logos in the 400 gig category from 75 customers last year to the first half was $1 50, and we're trending to about 300 customers. So the definitely 400 gig I need to double check on whether there was any 200 kg, let me beg off that question either.

I was just going to say Paul some of the commentaries on the deferred is probably irrelevant here too where we talked about the deferred balance becoming more cloud Titan heavy this quarter, whereas before it had been more other verticals et cetera, right. So I think that's something we may not have had revenue, but we've probably had activity deferred the revenue.

So we have some deferred 200 gig.

So that's what I thought just specific to issue the question specific to Facebook and Microsoft. I assume a lot of that revenue is being deferred or maybe it's not. The specific question.

Lot of that revenue is being deferred or maybe it's not.

The specific question.

Yeah, I think we grew our deferred revenue when we mixed step towards cloud and that includes new products right. So that's kind. So 200 gig and 400 gig?

Alright, can you give any comment about the outlook for next year?

We are going to at the analyst day, how about then?

I cant wait 30 minutes.

I'll keep you in suspense.

If you're on the East coast I apologize for keeping you up late but you'll make it short and sweet I think our analyst day would be two hours. Yes.

Yes.

We don't have to stay up too long.

I appreciate it.

Sure.

Paul.

Your next question comes from the line of Sami Badri with credit Suisse.

Thank you for the question. Jayshree you've mentioned a couple of times talking about restaurants to enterprise wins. That really kind of dial in golf as far as momentum, but if you were to bullet point the key reasons why you're winning you continue to win with what sounds like increasing momentum could you just highlight them for us because most of the people on this call are used to hearing about very dependable sales channels and many other vendors with very comprehensive solutions.

G suite.

And a couple of times talking about restaurants to enterprise wins.

That really kind of dial in golf as far as momentum, but if you were to bullet point. The key reasons why youre, winning you continue to win with what sounds like increasing momentum could you just highlight them for us because most of the people on this call are used to hearing about very dependable sales channels and many other vendors with very.

Solutions.

Could you walk us through the key sales pitch and just what is resonating with enterprise customers?

And again I'll give some of this at the analyst day, but I'll give you an abbreviated version. First of all, I think our relevance in the enterprise customer has increased from data center.

Well I think our relevance in the enterprise customer has increased from datacenter.

To a much broader portfolio that's client to cloud going all the way from campus Wi-Fi Wilander to spine designed the datacenter to routing. And a very large don't know of software and services as well everything from a character cloud vigilant to cloud in the US. As well as our recent acquisition of Big switch and awake now contributing as well to segmentation observer ability and security as well. So the completeness and the innovative nature of our portfolio has helped. The second thing that's helped is our power of one if you will one. One image one cloud vision customers just love the not just the innovation, but the quality and support I'm not having to buy silo boxes, but having an innovative and much better operator experience at a much lower TCO. And finally at the enterprise customers is that we have not much as we talk about products, we have invested in customers.

As well as our acquisition of Big switch and awake now contributing as well too.

segmentation observer ability and security as well. So the completeness and the innovative nature of our portfolio has helped. The second thing that's helped is our power of one if you will one. One image one cloud vision customers just love the not just the innovation, but the quality and support I'm not having to buy silo boxes, but having an innovative

and much better operator experience at a much lower TCO. And finally at the enterprise customers is that we have not much as we talk about products, we have invested in customers.

Our investment in sales led by Chris Schmidt and Ashwin and the entire team worldwide really began in 2017. So this is our third or fourth year of enterprise investment. And I think we're not seeing the results of that, but in the first and second half we were kind of getting in and we're just coming into the campus and now I think we're coming onto our own in a complete holistic fashion.

Fashion.

Your next question comes from the line of Jason Ader with William Blair.

Yeah. Thanks for the question. First I want to say horrible numbers, you guys need to do better. Sending out. But my question is can you quantify the backlog or book to bill or anything that might help us understand how much of a gap there is between demand and supply? And is there any risk that customers are over ordering right now where you could see an air gap in demand may be in sometime in 2022.

First I want to say horrible numbers, you guys need to do better.

Fair enough.

Sending out.

But my question is can you quantify the backlog or book to bill or anything that might help us understand.

How how much of a gap there is between demand and supply and is there any risk that customers are over ordering right now where you could see an air gap in demand may be in sometime in 2022.

Yeah, Jason, I know lots of folks have been talking about bookings and I'm trying to put some boundaries around that. I just think it's really hard from a timing perspective. When you have these lead times of course, you're going to have accelerated bookings and larger bookings uncertainty, we have our fair share of that right. If there's no. It's just difficult to talk about the business I think in that context. So we're more focused on what can we deploy and where it's at and that's how we're running it internally as well right.

I'm trying to put some boundaries around that I, just think it's really hard from a from a timing perspective. When you have these lead times of course, you're going to have accelerated.

bookings and larger bookings uncertainty, we have our fair share of that right. If there's no. It's just difficult to talk about the business I think in that context. So we're more focused on what can we deploy and where it's at and that's how we're running it internally as well right.

What are the periods where these bookings will get deployed and building out deployment plans. And that's really what's going to matter and I think when you think about the business that way you know the pull-ins and push outs of the actual bookings numbers and how much visibility you're getting et cetera becomes less important than I thought.

Not ducking your question you know we have obviously lots of demand we've talked about the demand that we have but these are extended lead times. So we're just focused on making sure we understand how it's going to get deployed. And I want to echo what Ita just said, we're not going to get excited about backlog, we're going to get excited about deploying our customers with real revenue.

And some of the backlogs may materialize and remember their cancel orders some of them may not. So it's best to be responsible as a company as we always have them and share with you that demand is suddenly outstripping supply, no question about that. And we're going to work hard as hell on fulfilling the supply and improving the supply.

Great next question please.

Thanks Jay.

Your next question comes from the line of meta Marshall with Morgan Stanley.

Great. Thanks.

You know I realize this is kind of difficult to quantify the supply chain impact currently, but if any way to help us with the gross margin impact and should we see the gross margin step down in the guide is more supply chain related or more related to the mix of revenue types.

Yeah I think.

The best way to think about it is that you know we've been operating at the upper end of that range for the last couple of quarters, that's definitely a customer mix effect, right. It's offsetting some of the cost impacts as well and you know we've been deferring some of the as Paul was talking about some of the larger customer revenue as well.

Some of the cost impacts.

Impacts as well and you know we've been deferring some of the as Paul was talking about some of the larger customer revenue as well.

So I think as you look forward kind of.

Outside of these quarters when the mix of the business comes back to something more balanced I think you will see us back towards the bottom end of that range from time to time I think we believe we'll stay in the range over a long period of time, but there will be quarters, where we could be pressuring the bottom end of that range or maybe even break the bottom end of that range, while for saying if any.

Four quarters, I think we can still be okay.

So there is definitely a customer element to this there's a cost increase element to this and we will benefit from some customer price increases here that will help offset some of that but I think the days of living at the upper end of that range I wouldn't assume that we can do that.

On an ongoing basis as you look forward.

Got it and not the tropics study forward guidance, but those are further price increases obviously, you probably won't see most of that impact for Q4, you would expect the price increases the impact more Q1 and 2022.

Yeah.

Yeah, It will take time.

Great. Thank you Congrats I think Peter Thank you.

Thanks meta.

Your next question comes from the line of David vote with UBS.

Great. Thank you guys for taking the question.

A question for both I guess to St. Jude I just wanted to follow up on the cloud tightened capex in hyperscale or Capex and the visibility I think it's fairly well documented that the balance of this year into 2022, there's going to be significant data center expansion and availability expansion by the Hyperscale and so that's clearly reflected in your confidence, but you noted that you know you have a little bit more.

Your visibility I mean, how should we think about 'twenty 'twenty three I know, we don't even F. 'twenty two guidance, yet, but given the strength of the expansion and the availability in the datacenter trajectory.

How do we think about that and then just as a follow up on pricing.

You know when you think about a 10% price hike that you can implement.

The weeks in.

In your mind is that sort of more than offsets the supply chain or is it is there a way to quantify how we're thinking about price versus the margin impact from the higher component does it reduce it by 50% is there some way to think about it that we can model out going forward. Thank you.

Yeah, No I mean, we've tried to be very transparent with customers in terms of what we're seeing on the cost side and looking for them to help us kind of offset that so we're definitely not looking to.

The increased margin or make margin on on that we've been we've been very open and transparent with what we're seeing on the cost side and looking for help to offset that.

Yeah and to answer your question on 'twenty 'twenty, three I guess I would say stay tuned for the analyst day, we will try and give you a better visibility on 2022 and give you some visionary statements on 2023 and beyond.

Great. Thank you guys.

Thanks, David.

Your next question comes from the line of Amit.

With Evercore ISI.

Perfect. Thank you and I'll extend my congratulations as well to you all.

When I look at your performance in 'twenty, one based on the midpoint of your guide for December I think you would have clearly gained some sizable market share in the year I'd love to understand do you think the share gains are coming from white box vendors are coming more from sort of the traditional competition that you have and then maybe a second part to this as you think about the next couple of years could you.

The customers that use white box solutions do they come to Arista and if so what do you think would motivate them to do so thank you.

Both very good questions unrelated to each other I would say this year with all the supply chain issues.

So more of our share gains is coming from enterprise and cloud Titans.

Just getting our fair share from our peers in the industry not not necessarily white box. If you fast forward to later years I do think Arista will have an advantage not just in product capability, but also in the ability to rapidly supply product probably better than some of the white boxes and I'm sure that is often alluded to this so the make buses.

Buy decision for many of our cloud Titans may may shift in the direction of Arista rather than strictly white boxes, we look forward to that I'm not going to make any guesses on that but I don't preclude that and neither has onshore when he has spoken in the past so it suddenly it wasn't part of the market share gains and the growth this year, but it could be next year.

Perfect. Thank you.

Right.

Your next question comes from the line of Pierre fare with a new.

St.

Hey, thanks for that.

It's not taking my question I'm very intrigued by your one year visibility you have with your cloud Titans and all that.

Frank I was wondering first phase.

One of your plan.

Capex I'll make steel body like 60, 65% or so.

Next week and I was wondering you've got some things that he said.

I would say lawn injuries, the visibility you have or if it came as a surprise.

And then in English headlined we didn't that visit.

Do you see the spending of cloud Titans changing in terms of how it is split between what's happening inside the data center, which is more on the switching side and what is more happening outside the data center.

And more on the routing side.

Thanks for that.

Thanks Pierre.

Again very good questions I'll take the second one first I think.

I reached his presence for most part until recently has been intra data center, but what has been phenomenal to watch my cloud Titan team do led by onshore Martin others is the use cases have proliferated not only outside the data center Dci, but routing AI use cases top of rack use cases special.

Customized use cases, so both within the data center and outside of just us getting its fair share of opportunity to respond and when we're doing a lot of proof of concepts and testing work with them regarding the cloud Titan Capex turned out we're always surprised with the numbers actually come out of it because they are in billions and of course, they are nowhere close to the percentage of their spend with.

Us necessarily.

But our relationship with Facebook.

Dates back now at least for five years, we have done joint development with them and they have boss and we've jointly developed products with them.

We have shared with you in the past that we are developing a next generation of product with them 200 gig. So we were pleasantly surprised but we were not completely surprised.

Thanks Joseph.

Great. Thank you.

Your next question comes from the line of Aaron Rakers with Wells Fargo.

Yeah. Thanks for taking the question and congratulations as well for me.

I think the one number that stands out the most to me is your $2 1 billion plus purchase commitments and I think that's up over four X relative to what it was exiting last year.

I think going into <unk>.

The June quarter, the expectations were that maybe some of these component constraints would start to ease as we move into the mid part of 2022 and certainly into the second half I'm. Just curious your best assessment right now where you stand on some of those lead times starting to normalize our shortened back down and you don't do it.

But youre going to carry you kind of a higher degree of visibility well into 2023 at this point. Thank you.

Okay.

And presenters are is your line muted.

Sorry about that I don't know when that.

So of that App and write it off.

Yeah, So I think likely.

Sorry, Aaron can you can you help me with how much of that you got.

Actually I didn't hear any of it I apologize, okay, alright, Okay, let me start.

Yeah, So I think look we've.

We probably have two dynamics happening, we've seen a push out of them.

Lead times again with the products and the vendors that we were managing directly and that's probably I think now our view is that's probably the end of 2022 before we start to see things get better there.

In addition to that we've also seen a kind of broaden out to other components right and we're now managing vendors.

Directly that would have normally gone through the supply chain gone through their contract manufacturers et cetera, and we're having to.

Engage directly with those suppliers and then that's also driving some increase in those and those purchase purchase commitments and we're looking out longer with those suppliers as well and so it's a combination I think of both of those just making that number increase.

We are trying to focus on new products and products that have long life cycles. So that gives us a little bit more leeway there in terms of taking longer and longer view and we'll continue to do that but yeah. I don't think we've kind of got to the point, yet where things are improving.

And we see this as an important investment to the business you know it.

It is a decision that the EDA myself.

It'll have made very consciously because they've got to invest in the business and we've got to invest in getting product to our customers. So we think this is an important part of our decision making process because of the prolonged situation here with the supply chain.

Very helpful. Thank you. Thanks.

Thanks Aaron.

Your next question comes from the line of <unk> Kidron with Oppenheimer.

Thanks, Hey, ladies congrats great quarter.

I guess a couple of questions for me first of all with regards to the purchase commitments can you give us a little bit more color. Whether this is a response to competitors of yours doing the same with your suppliers.

And does this lock in volume or does it also lock in price for the components that you're buying.

Yeah, No I think it's totally off working on our own strategy and as Jason mentioned area. We've started to do that right back at the beginning of last year, even and suggests a continuation of that I think that the biggest driver is obviously, what's happening in the supply chain and understanding what's happening in the supply chain and just the breadth of suppliers that we need to.

Managed directly and start to deal with directly right now and I think that's the biggest driver of the change as opposed to anything that Sam than anybody else is doing et cetera, I'm sorry, what was the second part of your question Anita.

Lock in just the volume or does it also lock in the prices for you going forward.

Yeah, I mean, you know when you make long term commitments. There is kind of a pricing element to that that you have a set price space you know as things start to get better we.

We will see how some of that plays out right, but there obviously is the pricing in the market today and that pricing is kind of what you're making these commitments that and.

But as time, we've seen over time in the past was as things start to loosen up and some of that can change as well, but right now it is a commitment to volume and price.

Thank you.

Thanks, Ed.

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

Thanks for taking the question.

As you probably remember early in my career I was told me never to high five management on a public call I'll I'll leave it at that.

Nonetheless.

I wanted to see if maybe you could expand a little bit on the campus opportunity, which sounds like it's overshadowed by what's going on in data center, but just wanted to get a better sense of where you stand in that part of your business and the trajectory. Thank you.

Thank you Simon if we will take your virtual high five.

Yeah.

Yeah, I think the campus business has been very relevant to a seat at the table in with enterprise customers. We're now starting to see enterprise wins and logos, where we win the campus before we went a datacenter because many of these campuses don't have large data. Many of these enterprises don't have large data centers. So I think the conversations are strong.

<unk> the ability to bring all of the silo datasets together, whether it's in your campus in one data center and the <unk>.

Core O N. A branch is very important and customers are looking to us to build their modern and modernize their enterprise networks. So from that standpoint, although the numbers are still small and we're talking about doubling from 100 to 200, we think it'll be extremely relevant strategically with enterprise customers and to grow obviously in the <unk>.

Few years, that's also a component of channels wherever it's still pretty nascent and most of our success and engagement to date is direct albeit fulfilled by channel, but we hope that will change over time and that will add further strength to our campus.

Thank you.

Thanks Simon.

And your next question comes from the line of tally Ani with Bank of America.

Hi, guys. I have two questions. One is just if you could give us an update on campus switching where you are versus your targets? f you said it, I apologize I just didn't hear it.

I have two questions. One is just if you could give us an update on campus switching.

Where you are versus your targets. If you said it I apologize I just didn't hear it.

And second I just.

Want to understand kind of about the accounting.

Can you go over again the price increases when are they kicking in if they kicked in already and then what happens with your cost of goods sold since it's on FIFO.

I'm, assuming it sounds like for like everyone else does it mean that.

Right now you're still recording.

Cheaper components. So the margins are higher I'm, just trying to or or or maybe I'm totally wrong. I just wanted to understand kind of the margin evolution as component pricing goes up and the pricing increases kick in.

Yeah. I mean go ahead, it's some combination of all of those are all there are some.

Expedite costs et cetera that end up being period expenses that we've been recognizing we recognize the chunk last quarter.

We have some again in Q3 and there are other costs like higher priced higher pricing increases etcetera that will end up being inventoried and will flow with the inventory and some of that obviously will burn through the inventory that we have in the.

In the supply chain and then we will start to see those costs those will line up better hopefully with some of the price increases that we are you know.

Passing on to customers as well I mean, this is it's going to be complex it won't necessarily be perfect right, but you know as we look at the various different scenarios, there's a better chance of those lining up with the with the price increases so that will help kind of offset some of that and finally tell on the campus.

We committed to double the $100 million.

Achievement, we had last year this year and there and here we are sitting two months away from the end of the year. So we believe we will meet it and we will have to set a new Gulf of next year.

Got it.

And just going back to the margin so I.

I know, you're probably going to discuss it tonight, but just in general how do we think about gross margin going forward.

Yeah, I mean, it's definitely part of the discussion later.

Right.

Thank you already mentioned.

What was mentioned already as we continue to believe with the price increase effective November 4th which will really be effective next year by the time, our customers realize it and see it.

We will we will be able to offset the escalating costs and our gross margin will depend on mix and as it is often said if we are heavily mixed on the cloud Titans, we could be on the low end of the 63 to 65 and pressured our gross margin there.

Heavily mixed on the enterprise, we could be on the mid to high end like we have been got it.

Okay, great. Thank you. Thanks.

Thanks, Phil.

Our next question comes from the line of Ben Bolan with Cleveland Research.

Okay.

Good afternoon. Thank you for taking the question.

G. Sri I was hoping you could talk a little bit about how you view that.

The current technology build out the new technology build outs for both enterprise and cloud as they start to transition into 204 hundred.

How do you see.

Similar or different versus what you saw.

From 2016 to 2018 with more cloud Titans building out 100, any any thoughts on duration behavior any code.

It takes it would be interesting thanks.

Sure Ben.

I think the cloud Titans behavior will be different than the enterprise behavior on the cloud Titan youre going to see a much more rapid inflection to 200 gig and 400 gig, especially in the spine layers and they up links at the top of rack and they've always been early and fast the doctor of speeds and technology, especially within a data center or even datacenter to datacenter.

So we are expecting an inflection of 204 hundred gig that basically has started this year was very challenged with ecosystem and availability of optics and even switches the last year.

The era of inflection in my view is really late this year and goes well into 2022 on the enterprise too we expect to have by the end of this year 300 customers.

204 hundred gig, primarily 400 gig I would say.

And as you know our customer base is more than 7000. So obviously 100 gig and 400 gig will continue to coexist and live happily ever after together, but we will start to see the uptick and adoption of 400 gig, Indiana and the high end and early adopters of enterprise as well like we're starting to see this year. So I think the next few years can.

The best characterized as inflection of new higher speeds like 204 hundred and the continuation on adoption of 100 gig in the mainstream enterprise.

Thanks Dmitry.

Thanks Ben.

Your next question comes from the line of Eric Percher with JMP Securities.

Yes congrats.

I'm curious.

How is the constraints are effected the 400 gig market. It sounds like you've been you've been doing well there but has that been a factor and does that make a difference from a market share perspective, do you have any advantage or disadvantage in terms of taxes for three or 400 gig components.

I think I'd say, we are as constrained on 400 gig components. As we are 100 gig components. So it's been a factor for all seat. We're just constrained what can I tell you.

But our market share continues to be strong in both we're doing well in both.

Our flagship.

Platform, the 7800, which is especially 400 gig dependent is one of the most popular products at the same time by 70 to 80 and one.

100 gig versions of 75, and 7800 are very very popular to.

Supply chain and for everything.

And this is gonna be picking one speed over the other.

Are the optics anything.

Anything different.

The optics was actually better than last year in terms of the ecosystem for 400 gig coming up that's not not different other than that it's actually improved for 400 gig.

Okay very good thank you.

Thank you.

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

Hi, guys. Thanks, very much I guess I wanted to go back to your statement earlier I'm paraphrasing, but I think you said you were running the business to demand rather than orders or something to that effect.

Could you go back and kind of expand upon that I'm just curious about what you meant on that I assume youre trying to.

You'll look through.

Customer order books and try to see what they really need as opposed to you know.

Excess ordering maybe you could just expand on that thanks.

It's actually the other way around George what we said is you know it's all the just in time and built a forecast and being extremely disciplined about.

Buying inventory only when the customer puts in an order has gone out the window, a little bit and because of these long lead times, we are having to plan.

Two order well ahead of the customer orders a forecast that's what we meant so it's built to be able to purchase orders to our supply chain rather than build to customer purchase orders if that makes sense.

Well since there's still constrained on long lead times, so, we're making a bet that the supply chain constraints.

Which I hope will eventually improve we'll favorite those of us who make those kind of purchase commitments. So we're having to get in there early and fast even before the customer orders come in.

Out of curiosity do you have any flexibility on those purchase commits I mean are they cancel on your side.

Most of the Commvault semiconductor components are noncancelable, but you know that's just the way the business is run we've been careful to choose components that we don't need to cancel like picking new products, which and taken common componentry across them. So we believe there's limited risk in the investment we've made.

Super Okay. Thanks, very much. Thanks, George operator, we have time for one more question.

Yeah.

Your final question comes from the line of John Lopez with vertical group.

Alright, thanks, so much for squeezing me in and I apologize because I understand the same topic.

But hopefully will be the last one we can cover the rest of the stuff on the analyst day.

This has been alluded to a few times if we look at your largest competitor they've also like roughly doubled their purchase commitments fairly recently, you're now doing the same.

The dollars collectively or like many multiples larger than either of you have ever carried.

I guess my question here is to what extent do you think inventories actually evolving into a competitive weapon as we think about 'twenty two and 'twenty three.

And maybe like to what extent does it introduce risk like if you can't get supply as fast or in the same quantities that you're envisioning now cannot influence your revenue outlook in 'twenty two or in 'twenty three.

Yeah, No I think there's no doubt that supply is shaping our revenue line right now almost more so than demand right. I think that that is a factor I think we are constrained.

So supply is definitely a factor. I think in terms of looking at the purchase commitments. We're working very carefully with the suppliers and again, we're expanding kind of the breadth of what we're doing.

Terms of looking at the purchase commitments.

We are we're working very carefully with the suppliers and again, we're expanding kind of the breadth of what we're doing.

And we are expanding kind of the lead times and the length of time that recovery with those purchase commitments.

And I think that's important and again, we're doing it on new products newer products that have <unk>.

Significant lives ahead of them, so really the risk we're taking somewhat as is tying up some cash et cetera, it's not because of the lifecycle of the products and stuff it's not.

It's not really an obsolescence risk right.

But it could take some time to burn through that inventory if things change, but I think it's well, it's a bet that sports, making we're making it obviously in consultation and discussion with customers et cetera, but it is kind of a longer lead time, and then a broader set of suppliers than we'd normally carry that's why you're seeing that big uptick.

We're not only doing it for the owners that we use to buffer in the past directly but we're also now doing it for components that would've come to us through the CMS.

And when in a normal supply environment.

Understood. Okay. Thanks for the thoughts.

Thank you very much.

This concludes the Arista Q3, 2021 earnings 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.

Yeah.

This concludes today's conference call. Thank you for participating you may now disconnect.

Okay.

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Q3 2021 Arista Networks Inc Earnings Call

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