Arista Networks Inc. (NYSE:ANET) Citi’s 2022 Global Technology Conference September 7, 2022 2:30 PM ET
Company Participants
Ita Brennan – Chief Financial Officer
Conference Call Participants
Jim Suva – Citi
Jim Suva
My name is Jim Suva. I’m the IT Hardware, Supply Chain and Telecom Equipment analyst. This fireside presentation is featuring Arista Networks, stock ticker ANET. A few housekeeping items, first, no media and no press. Disclosures are available at the check-in desk, as well as on the Citi Velocity website.
I also want to mention, please visit their Investor Relations website at Arista. On their Arista Investor Relations site is forward-looking and Safe Harbor statements, including their recently filed SEC documents, including their 10-K and 10-Q and 8-Ks and all the other Ks and Qs that they put up. I do want to mention also that in any investor subject to [indiscernible] needs to ensure that the applicable research agreement is in place.
With that, I’d like to introduce the Chief Financial Officer, Ita. She’s here on stage with us, and Liz is in the back of the room also. I’ve got about 15 – 10 to 15 minutes of prepared Q&A that we’re going to do with Ita. Then it’s going to open up to everybody in the audience. When it’s time for the investor Q&A, please raise your hand and we’ll get the microphone to you as this is being webcast and it’s great to see the turnout here.
So Ita, thank you so much for joining us. I’ll ask my question and then I’ll join next to you here on the seats. Is your sales growth has actually exceeded and accelerated and shows no data center demand slowdown or growth and slowdown. Yet the economy with raising interest rates, PC slowing, consumer electronics are slowing, people are a little concerned there. So any thoughts on the sustainability of that demand?
Ita Brennan
Yes. No, we’re – I think we’re in a period of strong investments in the network across the various pieces of the business. We came out of probably a period of lower investments than what we’ve seen historically. Certainly with our some of the hyperscale customers, et cetera, it had been a period of lower investment.
And now, we’re starting to see them return to investing in the network. We have roughly 12 months or so of visibility right now because of some of the supply issues. So that gives you some decent visibility into kind of what’s ahead of us. Again, in terms of slowdowns, et cetera, I think they – there are technology reasons. We have a new product cycle with 400 gig on the hyperscale side, we have on the enterprise side and campus side, you’re see – there’s new technologies around campus and the data center for the enterprise where customers are making technology decisions.
If you think about a typical campus network for example, you’re back to work, you’re back to the office. There’s new pressures on the network in terms of just how people are interacting with the network. All of that is causing customers I think to make some interesting technology decisions. And if anything, they’re struggling kind of to deploy and meet those needs given the current supply environment and the supply environment that we’ve been dealing with.
So I think we’ve been clear that we haven’t seen anything in the business, obviously with all of the discussion that there is around recession and other challenges we’re watching very carefully. To see if there’s been any change there, but we haven’t seen anything actively happening in the business that that’s different.
Jim Suva
And from an end market perspective, what’s the greatest growth opportunity or end market expansion opportunities that you at Arista are looking at and smiling and saying, this is pretty major here.
Ita Brennan
Yes. I mean, we don’t necessarily smile too often. We’re really focused on just kind of what are the next kind of incremental steps that we can take and steps that we can make to continue to expand and grow the business. I mean obviously cloud is a big piece of the business and we continue to focus on those customers.
There are [Technical Difficulty] technology, technology roadmaps, et cetera. So there’s a big focus on being aligned with those customers in terms of long-term planning, roadmap planning, looking for new capabilities for those customers, that collaboration is really what leads to a strong position in those accounts and continue to be able to go back cycle after cycle and take your fair share of that business. So I think that’s definitely a continued focus and from the team have done an amazing job of doing that. And that’s a very interesting kind of part of the business.
On the other hand, on the enterprise side, it’s been really interesting to watch how all of the things that were relevant to cloud in the past are now relevant to the enterprise as well, right. And you’ve seen – you see enterprise customers looking for that same simplicity and robustness and operational efficiencies because their businesses have – are now subject to the same demands if you like as what was a cloud phenomena early on.
So if you’re an enterprise and IT is now part of your business model and your business is dependent on that, then you need all those same metrics. So it’s been very interesting to see that kind of the expansion of all of those same capabilities that we’re initially focused on cloud are now super important when we’re competing in the enterprise and the use of cloud vision as kind of the management tool for the enterprise, which again is very much based on kind of how cloud scale, hyperscale customers manage their networks and that they – how that’s resonating with enterprise customers has been good.
So we’ve seen that enterprise business continue to grow very nicely. We add a campus, we’re seeing the campus business grow and we continue to see new many verticals and expansion into new many verticals within that enterprise piece of the business. So that’s pretty exciting. I think for the team, that’s very interesting as you start to finally see kind of all those same metrics resonate with the enterprise and the way that it did with cloud previously.
Jim Suva
And you’re currently forecasting growth of around I believe it is 30% or more for this year and that comes off of also a very strong last year. So it’s not like easy math there. It’s compounding actually. And then with 12 months of visibility things look great, but yet how come margins are under pressure? As CFO, I’m sure you keep an eye on that. Can you help us understand visibility so good, growth so good, but margins under pressure?
Ita Brennan
Yes. I think it’s all about supply, right? I mean the supply environment is obviously been difficult. Supply has experienced multiple shocks over the last number of years. If you think about COVID, we’ve had tariffs, we’ve had shutdowns because driven by COVID freight has been scarcities and freight because there was no travel, et cetera, et cetera.
There’s been multiple things that have kind of disrupted on the supply side and we’re still working hard to kind of get back to something more normal. We’ve seen kind of freight costs elevated. We’ve seen expedite fees on a consistent basis. And more recently, you’ve seen the decommit, dynamic where small number of suppliers are decommitting close to a committed kind of ship date. And then that’s causing us to go out into broker markets, et cetera, and spend significant amounts of money to secure parts to not have to decommit kind of our customers, right?
So that’s all pressuring gross margin, right? On the operating margin line, obviously the strength of the business that you’ve seen, the growth of the business that you’ve seen is helping to offset that. We’ve actually seen some expansion of operating margin in spite of that, that, that gross margin hit if you like in the last couple of quarters.
So I think we’ll continue to responsibly do what we can do on the supply side to make sure we meet commitments to customers. And obviously, the strength in the business, if you’re successful at being able to ship is helping to offset that and the operating margin line has actually been doing quite well.
Jim Suva
[Indiscernible] and they talked about acceleration of its then which is unfortunate or you have been some decommits also have, the decommits become stabilized, gotten a little bit better or actually worse.
Ita Brennan
We started to talk about this, I think probably a little earlier actually than at Q1, I think we had talked about it for the first time and starting to see this phenomena. And again, it’s a very small number of parts that we normally wouldn’t focus on at all. But they’re very constrained and not only are they constrained, but they’re struggling to be able to predictably commit to what they can deliver.
So you can – you don’t really get certainty or anything close to certainty until you get closer to your quarter to the quarter that, that, that you’re addressing. That’s part of why we didn’t kind of re-guide Q4, on the last call, just because again to really sure where you stand with this particular dynamic, you need to be closer.
But we’ve seen, I think we saw a slight improvement heading into the – with the Q3 guide, but again, we need to string together a couple of quarters of that to show that consistency. I think we’re not quite there yet. We’ll see kind of what we do for Q4 and that will help kind of answer that question.
Jim Suva
So I lied to you. I said, you’d have a good one-on-one schedule. And I don’t think there was a single one-on-one meeting. It’s all groups meeting with you and there’s still even people standing in the room here. It’s just absolutely packed. So I’m sorry that you’re not getting true one-on-one time, it’s actually mob group of people that want to meet with you, which is a good situation.
So with that, there’s so many people in this room, I’d like to be very respectful of the investors to give them a chance to ask a question too. So because this is being webcast, if you could please raise your hand and we’ll get the microphone to right away to ask a question as it is being webcast. But any questions from those in the audience otherwise, I can continue on with my very knowledgeable list of questions for Ita.
Question-and-Answer Session
A – Ita Brennan
[Indiscernible] Jim.
Jim Suva
I think was there a question over on this side? Okay. I got to ask you this capital allocation, the stock market’s been under pressure. Many stocks have been under pressure. You’re the CFO. You’ve got Jayshree who wants to grow the company, grow the company, grow the company. You’ve got investors in this room who look at the stock price and see it as being very attractively valued. How do you look at capital allocation?
Ita Brennan
Yes. Look, I think we’re fortunate in that we can do many things at the same time and that we have kind of the means to do that with the business model that we have. The business is obviously priority number one, and making sure that we continue to make the investments we want to make, whether that’s R&D headcount, go-to-market, whether it’s supply chain right now and being able to kind of make the commitments that we’ve made around the supply chain.
So the business is probably the first, when you think about it is probably the first place where we believe we should use that cash and we should make the investments that we need to make. In terms of the buyback, I mean we’ve been pretty active. Again, our goal is obviously as a base level to offset dilution and then be somewhat opportunistic beyond that we’re pretty active last quarter, when the market give us an opportunity, we have about $300 million left on the buyback and we’ll continue to execute against that.
M&A, I think we’ve talked quite a bit about M&A, it’s definitely a lever. We all understand that it’s a lever but we have pretty high bar in terms of criteria for what makes sense, right? That’s led us so far to do things that have been more technology focused, adding technology features that maybe it’s better like the Wi-Fi, for example, where you don’t start from scratch, you can acquire some capabilities there.
Adding, I think capabilities in technology, like with the wake where we got, a very strong security team focused on the network that allows us to kind of integrate to some integration with EOS, et cetera, there that’s pretty special. And now you have a team of experts in house on the security side. Larger acquisitions have been hard for us to find that would kind of meet the criteria. But again, it is a lever and it’s something that we’ll continue to look at.
Jim Suva
Great. Questions from those in the audience, please raise your hand. We have a question right here in the very front row. If you can please wait in the microphone, we’ll make its way to you here in a minute.
Unidentified Analyst
Thank you. I just want to go back to something Jim asked you, just about thinking about the full year given the strength you saw in the first half of the year and the strength you’re going to see in the third quarter or at least in your guidance. He asked you about kind of 30% growth guidance for the year. And just to drill down a little bit on that, how much do you think that is gated just by components? Are there tougher compares coming up? Like how do you think about, how do you frame the second half of the year when you think about the puts and takes around that? Thank you.
Ita Brennan
Yes. I think the constraint right now on the business is really supply, right. And the uncertainty has been driven by this supply and decommit dynamic that we’re seeing, right? So I think the – clearly the demand, the deployment schedules, et cetera, I mean, there are in place, right? We’ve done a lot on the supply side and it’s down to this handful of components really that that’s what’s gating the business, right?
Jim Suva
There’s a question here in the middle of the room.
Unidentified Analyst
Thanks. Just when you think about your international growth strategy and just the huge opportunity that is in chunking it down, what’s the plan to thinking there in terms of really sort of exploiting that.
Ita Brennan
Yes. I think we continue to – if you look at where we’re adding sales resources and adding go-to-market resources overall, we’re definitely growing faster internationally than we are in the U.S. at this point. So there is kind of a focus on kind of expanding that that international business. And we are seeing good growth in that large enterprise part of that business internationally, and both EMEA and APAC kind of continue to grow that, that part of the business continues to grow nicely.
In terms of looking at it as a percentage of the business, when you think internationally, there’s a fair amount of that overall business, that’s gets tied up in kind of the service provider telco part of the market and that’s a market that’s early for us, and we’re continuing to kind of figure out how to penetrate that.
So that, that does drive – that does – is a part of the market that as you figure out the service provider, there tends to be more international coverage there than maybe what’s in our model today without that, but that’s part of that dynamic. So for us right now, the focus is obviously cloud deploys internationally that’s part of that driving that enterprise piece and then working kind of with service providers internationally for opportunities where we can engage, but that just hasn’t been as big a part of the business yet.
Jim Suva
Additional questions from the audience. I got emailed a question asking about how important is China for your end market sales, as the government has been putting in some more restrictive covenants or obligations.
Ita Brennan
So that’s not a major part of the businesses, because we never really built out that footprint. We do some business with Chinese hyperscale customers, but it’s generally outside of China, and again, it’s a smaller part of the business.
Jim Suva
Additional questions packed room. You implemented some product price increases. I believe it was February of this year or something. I remember you had a product increase. Can you talk to us about maybe what that was? Is it fully rolled out? I assume your backlog is still priced on pre-price increases and it should be helping your gross margins maybe in a couple of quarters.
Ita Brennan
Yes. So we did two price increases. One was back in November last year roughly 5% to 10% kind of across the hardware piece of the business. We did reprice backlog or kind of quotes that were already in flights. So we’ll start to get some benefit from that roughly back end of Q4 of this year. The second price increase was in April of this year again kind of 5% to 10%, but on a smaller subset of components, really on products where we felt like we could demonstrate that we’d had cost increases, et cetera. So that’ll kick in sometime 12 months from there, so Q2 some Q3 of next year.
Jim Suva
Okay. So margins are looking pretty good for next year, then assuming supply chain golden screw missing parts don’t get worse with decommits.
Ita Brennan
Yes. I mean, it’s back to the all other things being equal criteria, which is always hard to meet, right. I mean, obviously, if you think about the drivers, you still – customer mix is still a factor there. So depending on where a customer mix is at the decommit dynamic for sure and that going away would help – will help with gross margins. And then overall, we’ll get the pricing – some benefit from pricing and then we’ll see what happens with supply chain, right. But I think it’s – yes, there’s a number of different moving pieces there.
Jim Suva
Additional questions. On cloud, your Cloud Titans, you’re having a fantastic year of growth, really fantastic. Is it being consumed and implemented or is there any concern about a buffer of inventory being built where when we face a digestion phase in the future?
Ita Brennan
Yes. I mean, I think we’ve – we have seen a recovery in the cloud hyperscale business and certainly with new products, et cetera, you’re seeing improved demand. There is a constraint on that business from supply. I don’t think we’re anywhere near a point where folks can start building buffers, honestly. I mean, we’re very much challenged to supply what they need kind of in their operations today, right. So I think we’re a long ways away from being able to build – rebuild buffers. I think really the focus now is just on getting them what they need operationally today.
Jim Suva
So they’re consuming basically everything once you ship it to their dock, it sounds like…
Ita Brennan
Certainly, the focus that’s on supply from their side across the various teams in these accounts indicates that it’s still front and center needing supply to support the business. Okay.
Jim Suva
There’s a question on the right side of the room right here.
Unidentified Analyst
Yes. If I could understand that just a little bit more – we’ve been hearing some different data points from various folks in the value chain, whether it’s companies like Marvel talking about potential weakness on the data center side or Seagate talking about last week that they were seeing weakness from some of their cloud customers. And one of the things that’s hard to tell is, are the cloud customer – are the cloud providers slowing down their data center growth because they’re full on – they’ve built enough capacity and they’re going to try to utilize it or because they don’t have as much visibility on the lead time of the supply components that they need to build their data centers such that they’re reducing or they’re cutting back how much they’re going to build. What’s your perception on that based on what you’re seeing?
Ita Brennan
Yes. I mean, again, we haven’t seen that dynamic. I mean, it’s hard to imagine right now with the urgency that they’re displaying around this that anybody would actually kind of turn away from supply either because they’re waiting for another component or whatever, right. That’s just not the environment right now. I mean, there’s – if people can secure a supply there, it appears at least that they’re going to take it, right. We haven’t seen any dynamic where a customer either enterprise or hyperscale honestly wants to say, no, I’m happy to give up my slot and come back in nine, 12 months, right.
Jim Suva
There’s a question right here in the front row in the center.
Unidentified Analyst
I certainly understand that the supply constraints, but that would obviously make it even sort of less likely that a customer would get out of the queue. And I suppose just wondering this time and this cycle versus back to 2018 and 2019, what can the industry in a risk to do better to see some of that potential lumpiness that might come out of hyperscalers or pauses that might come out of hyperscalers?
Ita Brennan
Yes. I mean, look, you can’t – the customer is going to deploy what the customer needs at the end of the day. And I think we’re at the beginnings of this 400 gig deployment cycles were come off a period where those customers were underinvested. So best as we can see for the foreseeable future, there is – that there is healthy demand there and there’re anxious to deploy that demand, right. At the end of the day, customers can provide a certain amount of visibility. They’re providing 12 months of visibility, which is a big improvement from what we had back then.
And then they’re going to have to respond to their business. And it’s hard to kind of expect them to predict much beyond that, to be honest, right. So I think we just have to continue to work with customers, make sure we understand their – what they need, what they’re seeing in their businesses and respond to that as best we can. It’s better in terms of having the visibility that we have this time around, but you really – I mean, at the end of the day, if customers orders are in response to their business and how they’re doing and what they need in their networks.
Jim Suva
There’s a question towards the center of the aisle here, midway the microphone will be there in a couple seconds.
Unidentified Analyst
On that point, Ita, could you talk a little bit more about how you interact with customers and how you try to fit a solution or just how you charge for it differently by vertical, I’ve heard anecdotally that your approach is more flexible than some of your peers. But it’d be helpful to hear just example or two.
Ita Brennan
Yes. I mean, I think there’s always – it’s always been a culture of, first of all, it’s engineers to engineers in a lot of cases, right. Both again in hyperscale and on the enterprise side. So it’s very much around coming up with a solution that solves customers problem that makes the customer’s network – improves the customer’s network, reduces their operating costs and providing that visibility to the customer, right. I think that’s the – being able to kind of collaborate through kind of the solution to the problem being able to show as part of that, just how what the benefits of the solution are – is fundamental to a pricing discussion, right. I mean, there’s lots of cases where customers may have different pricing mechanisms that they’d like to have and we’re very flexible around that.
And again, that’s – some of that’s benefited from the fact that we have a large enterprise, large focus, right? So it’s easier to be a little bit more flexible. But a lot of kind of the value in the sale at the end of the day comes from the customer being convinced of those operational savings and the quality of the solution on a relative basis, right? Then you can respond on the CapEx side, you’ve got some – you’ve already established value, right? And that certainly helps when it comes to kind of the pricing discussion. So I think we are more flexible just because they’re larger customers. We can afford to be more flexible given that the size of those customers. And then secondly, that value – convincing of value early on in the cycle [indiscernible] it gets to really the pricing discussions.
Jim Suva
Great. Thank you for the question. Any additional questions? I get asked a lot about, what’s the kind of common theme that you’re clarifying in your one-on-one or group meetings with investors that may be in front of this very large group meeting and people standing in the back and webcast that maybe you can clarify to kind of mitigate some of their concerns or things like that.
Ita Brennan
Yes. Look, we spend a lot of time, obviously, talking about things we’ve talked about so far supply and demand and recession, et cetera. And I think, again, just to reiterate on that, we’re working hard on the supply side. We haven’t seen any recessionary impacts in the business. We are obviously being very careful and monitoring for that. Just given all of the discussion and everything that you see in the marketplace, but the business itself has remained robust at this point. I think in terms of, what’s interesting, I think, what we talk about a lot to investors is, is this idea of taking kind of the core building blocks of technology and the solution that we develop for cloud and then expanding that to the enterprise and to the other pieces of the market.
And that’s – from a customer perspective, that’s super important. From a sales perspective, that’s important. But from a business model, it’s important as well, right. I mean, it is having that leverage on the R&D base and being able to kind of take that technology that’s initially kind of focused on cloud, but then becomes so relevant across the other pieces of the business. It gives the business model a lot of capabilities, right. That’s why you see – when you do scale revenues like we did in the last quarter, even with the gross margin hit, there’s still operating – increased operating leverage just because of the efficiency of that model.
So I think that’s one thing that we’ve been talking more, I think with investors about is the fact that there is very strong leverage across kind of the technology investments. And now that the enterprise customers that’s resonating with them and you see customers want that simplicity of solution in the enterprise in the same way as cloud did that there’s a lot of leverage there and that’s helping to drive kind of some of the traction we’ve seen in enterprise for sure.
Jim Suva
That’s a very good point. One last round for questions for the Chief Financial Officer of Arista Networks. I have to ask this. I’ve known you a long time. You’ve been through cycles in optical, you’ve been through cycles in switching and routing, you’ve been through economic cycles. I’ve known you for so long. What do you want investors to walk away from this meeting about why they should be buying and owning Arista Networks?
Ita Brennan
I mean, I think it comes back to the last question, right? I mean, this is a company that’s built on technology that has huge relevance to a very large market at the end of the day. If you think about kind of the market that we’re addressing now and we’ve been expanding that TAM, data center routing plus campus, plus some of the software capabilities that we’re bringing. It’s a very large time and we’re at a relatively early stage in that, right. And I think we have demonstrated that over time, we can continue to execute and take share. And we’re at the early innings on a lot of those activities, right? So I think the TAM is there. I think the technology is proven, the go-to-market is working and that’s something that we did need to prove, right?
That you could go and win in enterprise accounts, et cetera, against the incumbents, but we’re executing on that now. And so there – if you look at the size of these markets and where we are, there’s considerable runway ahead to keep doing that. What we need to do is keep executing and continuing to execute on the technology side and on the go-to-market side, but certainly the opportunity is there. And as you do that, the business model is robust, right? It is – it’s a very clean business model, it’s – it allows for growth and cloud and growth and enterprise and operating margins are pretty consistent across that. So it’s a really healthy business model with a large time that we can grow into, right. It’s all about execution and that’s kind of our job day to day.
Jim Suva
I got an email, saying, sounds like there’s more interest in this than the Liverpool soccer game.
Ita Brennan
Well, right now there is that’s for sure.
Jim Suva
Yes. That being said, can you ask Ita about what are the chances of introducing some new cloud logos, say, over the next 12 months. There’s been some chatter about Google Cloud and others about potentially not using a 100% white boxes and potentially using some other branded OEMs.
Ita Brennan
Yes. I mean, look, we’re always looking for new opportunities to expand that cloud business, it goes back to the same thing, continuing collaboration, focus on the product and the technology. Yes. But all of these things take time, right. It’s – but obviously, we put considerable effort into looking at kind of ways to expand that business.
Jim Suva
And then another question I got is, in the past, sometimes some of your large – or your large customers have skipped a server or router or technology generation node, whether it be Intel or chips or something like that. Does that tend to happen again where you saw that I think was with Facebook, like five years ago or something like that, any of that happening again? Or are they kind of learned, it’s not wise to skip a technology node?
Ita Brennan
Yes. I mean, I think we saw that back at the end of 2019, and I think the reason that they felt they could do that was because we’d come out of a period of significant investment large deployments, et cetera. If you fast forward to today and this question comes up obviously because of some roadmap discussions around the CPU chips. But if you fast forward to today, we’re in a different phase of that cycle, right. Again, back to the kind of the urgency with which these customers are pursuing supply. It doesn’t seem like it’s a period of time where somebody can say, okay, I’m going to pause and not make these investments right now.
Jim Suva
Ladies and gentlemen, thanks so much for joining us here today. And thank you, Ita and Liz for coming all the way from the Bay Area with me. Bye-Bye.
Ita Brennan
Thank you.
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