Arista Networks, Inc. (NYSE:ANET) Raymond James TMT & Consumer Conference December 5, 2023 1:40 PM ET
Company Participants
Ita Brennan – CFO
Liz Stine – IR
Conference Call Participants
Simon Leopold – Raymond James
Simon Leopold
Thank you very much folks for joining us. My name is Simon Leopold, Raymond James’ Data Infrastructure Analyst, and I am pleased to welcome for our fireside. We have with us from Arista. We have Ita Brennan, CFO, retiring in a few months. So, we are grateful that you are spending your remaining time with us; and Liz Stine, who is running the IR department.
So format for this is fireside chat. I have got an outline of questions that I will go through. But love to get questions from the audience. If you wave at me, I will try to try to call on you and we will repeat questions or we will check in towards the end to see if you have got any questions. Do you need to read any disclaimer or anything like that? Okay, awesome. I hate when I am responsible for that.
Ita Brennan
We could have made you responsible for that.
Question-and-Answer Session
Q – Simon Leopold
I know. It is too much for me. You’d think I’d have it memorized by now. So, I want to sort of reflect back on the recent Analyst Day because you provided an outlook for ’24 longer-term. And so, I like the timing of our meeting because in December, everybody’s thinking about 2024. So you forecast this 10% to 12% outlook. Help us get a better understanding of what informed you in terms of whether it’s thinking about the verticals, the trends, the cycles, back up what led to a 10% to 12% growth outlook for the next year?
Ita Brennan
I mean, obviously, we are coming off of — sorry, is that better?
Simon Leopold
Nope.
Ita Brennan
Okay. We are going to try that again. Yes, we are coming off of two years of fairly aggressive growth and pretty elevated spending from cloud. So, I think we have been saying for some time that we thought kind of 2024 would be a more moderated cloud year, and we are kind of coming out of the 400 gig cycle a little bit, and then you are starting to talk about and think about 800 gig. So, it’s been kind of our belief for some time that if we see cyclicality, this is kind of when we would see it. So that’s definitely underpinning of the growth rate as we think about 2024.
But obviously, the enterprise piece of the business that has continued to do well, it continues to grow nicely, A little bit accelerated in ’23 with some supply chain stuff. But even when you normalize for that, was kind of slower in ’22, a little bit faster in ’23. But when you normalize for that, it is still been growing very nicely, very consistently. So that’s also an input. So taking kind of that, and then thinking about that cyclicality, thinking about deployments that we know about and what can see discussions with customers, et cetera. I mean, all of that informs kind of that 10% to 12%.
And again, we like to have a couple of different ways to get there because it is early to be sitting here talking about the whole of 2024. So having a couple of different models that can get you there is important, and then we will see where we go from there.
Simon Leopold
So, I appreciate that you are not guiding by vertical. But maybe it’d be helpful to sort of get some sensitivity around the three verticals you talk about, Cloud Titans, Enterprise, and then Service Provider/Other which do you sort of fear above and below? Which sort of have the greatest variability? Which do you have the greatest confidence in?
Ita Brennan
Yes, look, I think it’s probably too early honestly to start to kind of pull it apart in that way. I mean, we do — again, have multiple different models that kind of assume different things about those verticals. That’s part of kind of how you get comfortable with the view. But I think it’s too early for us start saying here is a single path that’s get you there. I mean we talked a little about the cloud just because it’s a driver of kind of the change in the growth rate. But other than that, I think we’re just going to go kind of quarter-by-quarter. Maybe mid-year, we typically start to talk about a little bit more about kind of the customer and the vertical breakout.
Simon Leopold
And one of the common themes we’ve been talking about is the post-pandemic normalization. So companies sort of entered the supply chain constraints at a different point and built up different level of backlog. And so, I’ve sort of looked at having backlogs and insurance policy in the near term, but then it creates a tougher comparison later on. Where is Arista in terms of this cycle of adjusting to normalized backlog and normalized trends?
Ita Brennan
Yes, so we don’t talk about backlog and bookings, and we very much decided as we came into this supply chain cycle that it was unhelpful really to talk about or to try to talk about bookings in a timeframe where you’re planning horizon was going from a quarter to 12, 18 months. It’s very hard to say that a bookings number has any real significance in that environment. So, what we tried to do was to take the bookings and kind of turn it on its side and figure out exactly when these deployments belonged almost.
So where and when should they be deployed? And we’re continuing to do some of that still, where we’re making sure we prioritize shipments obviously early on, now we’re making sure that we’re kind of putting shipping to customers when they need it, when it needs to be deployed, et cetera. And I think that helps manage some of that adjustment that you’re talking about.
But there’s still no easy way to go from18 months of lead time to wherever we’ll end up 6 plus or minus. You do lose some visibility as you make that transition. We’ve been talking about that, the reduced visibility. But I think if you focus on the deployments that’s kind of the right that gives you the best measure you can have of the business when you’re trying to make that transition.
Simon Leopold
And I do feel like talking as if there’s a true normal is a little bit nonsensical. That is my preface. Are we closer to normal or are we still sort of working through that?
Ita Brennan
Yes, I mean, again, in terms of the business and the deployments, we’ve been — that’s the underlying business. So what you’re seeing in revenue and for us is really the underlying business and when customers really needed to have that deployed. So, I think from a business perspective, we’ve kind of — we looked through the bookings to kind of when do customers actually want to deploy stuff? In terms of lead times, are we back to normal? I think, Jayshree had talked about kind of improving, 50% better than where it was coming into the year. I think by the end of the year, we’ll be more or less back to kind of where we want to be from a lead time perspective.
Simon Leopold
Great. And I want to explore specifically your thoughts on the enterprise vertical. And really the context of this question is broader around kind of the macro economy and how much that affects you in that we’re here debating? Are interest rates going down? Is the economy healthy? Did we dodge the recession? Did we not dodge the recession? All these debates and I want to get a sense of what’s sort of your take on it. You have to have a view, and then how does it affect your thinking for forecasting and the business?
Ita Brennan
Yes, I mean, it seems like we’ve been having this conversation now for years. I mean, really since we came out of COVID, it’s been a question of kind of what’s going to happen in terms of what recession, et cetera. I mean, again, I don’t know that we’ve seen that have a huge impact on the business, and part of it is we’re share gainers in that space. We’re targeting accounts, new win accounts, et cetera.
So, we tend to be qualifying accounts on the basis that they have an intent to spend. They have essential would say they have money to spend. That’s the first thing you should qualify an account on when you engage with an account. So, there’s some protection in that for sure because you’re not just exposed to the whole market. But having said that, if there were to be a serious macro impact then I think it would impact us as well. I mean, there’s no evading that if you had a serious kind of distortion in the market.
Simon Leopold
And sort of in light of that, the other angle is how you think about hiring plans? And really as I’m sort of thinking about my group, I’m seeing many of my companies having to do layoffs because they’ve over hired and things are slowing where you’re in a very different situation. Your revenue grew far faster than you could hire. So with the way you see the business evolving, what are you thinking about in terms of hiring objectives and sort of budgeting for that?
Ita Brennan
Yes, I mean, obviously, when cloud bursts and the way that it did in ‘22, ‘23, we don’t hire to that burst, right, because it doesn’t really make sense. I mean, we have a very kind of methodical continuing hiring of software headcount as we can find those. And that’s become a little bit easier of late. And then on the sales side, it’s really focused on the enterprise piece of the business largely, right.
So, we want to protect that regardless of what’s happening with cloud to some degree, right. So, again, that’s more of a continuing hiring against that enterprise. As long as we see return on those hires, as long as we see productivity on those hires on the enterprise side of the house, we’ll keep doing that. So that’s why operating margin sometimes will peak when you’ve got that accelerated growth. But then we might claw back a little bit of that as we continue to invest in sales and marketing, for example, for the enterprise.
Simon Leopold
And I guess maybe a related question is you seem to be under penetrated internationally. How are you thinking about an investment to grow your international presence?
Ita Brennan
Yes, we have been hiring probably a larger portion of the headcount that we’ve been done, has been going into some of those international markets. And again, we’ll continue to do that. It’s been more developed markets more of the kind of parts of the world as our primary kind of target. So, we’ll continue to build out that enterprise footprint and, and add to that, I think we’ve been trying to target like a 30% increase in headcount every year.
If we could do that, we think that’s something of a sweet spot where you can do it and maintain productivity. So that’s the plan. I think we never really got ahead of ourselves in terms of hiring. Like, we’ve always been very cautious around making sure that when we’re hiring, we’re being thoughtful about that. And thankfully, we haven’t had to really have a significant layoff.
Simon Leopold
So I’m going to pivot to the favorite topic AI because what meeting coming up AI. So, you established this target of $750 million of AI related sales by 2025. First off, help us understand what’s included in that number? What’s the composition assumptions behind it?
Ita Brennan
Yes, I mean, we’re trying to isolate kind of the backend AI revenues. So, things that are connecting directly, connecting GPUs on the backend Ethernet obviously because that’s where we play — it’s got to be, it’s not going to be perfect in terms of how you track that, but what’s — hopefully with the help of customers, et cetera, we can do that for some period of time.
I mean, I still think after, if it’s a year, 18 months, two years you won’t care anymore. What’s an AI dollar versus a non-AI dollar? But I think for this transition period, where there is these technology discussions and choices, it is helpful to try to give some indication of how we are doing there. So we are going to hopefully work with customers to identify that back-end business, and that’s what would be included in that number.
Simon Leopold
And just to be clear, the opportunity that AI presents is not just about building AI clusters, and what you are referring to as the back-end, but there is also this front-end opportunity, that’s not part of 750?
Ita Brennan
That’s not part of the 750.
Simon Leopold
And I think what you have said on there on the last call, maybe it was at the analyst meeting is, hey, we are not sizing that because we don’t know how to create a dividing line.
Ita Brennan
Yes, it’s the same products.
Simon Leopold
So is there a way to sort of think about, hey, here is the market forecast. If we subtract what we think is AI, what’s left, just, what’s your TAM maybe is the way to think about it, so AI plus non-AI?
Ita Brennan
I mean, we talked about the TAM stuff at the Analyst Day, and you can see that, if you look at the — what’s interesting is to look at the TAM say, from the last Analyst Day, let’s say, to this Analyst Day, we kind of increased the TAM by about $10 billion. About $5 billion of that is really AI and the AI opportunity in 2027.
So that’s incremental from an industry analyst perspective in terms of how they are thinking about that’s total Ethernet AI. Now, again, that’s not perfect today for sure because in some ways, we don’t know what that split is. So it is going to be hard for everybody else to track it, but it is at least starting to do a sizing on kind of what that AI Ethernet opportunity full opportunity can be.
Simon Leopold
So one of the questions we are often getting is that, InfiniBand is the choice for the back-end today, and I think everybody in the Ethernet camp is singing the same theme of, in a few years, it is going to pivot to Ethernet. I am an Ethernet biased guy as well. So, I like to hear that as do my peers.
But I think we are all struggling because the vendor of InfiniBand and the vendor of the GPUs really has a lock on that. They don’t have a huge incentive to change. Now they have said, look, we will do Ethernet too. But what sort of informs you from the marketplace, from the operators that we are really going to see this transition by 2025?
Ita Brennan
Do you want to take a shot at that from the technology perspective?
Liz Stine
I think the benefits of Ethernet are really seen at scale. And as these as these environments get larger and larger and you have seen, some of the cloud guys put out, some of these white papers now that are actually talking about their Ethernet environments, and benchmarking them against from a performance standpoint. And then if you listen to them speaking, the scale just keeps getting kind of larger and larger.
InfiniBand has some hard address limitations that limit the size of the cluster size. And when you think about Ethernet today, Ethernet is everywhere. And it can scale. And they are already running these large Ethernet cloud environments, and have the tooling and have the expertise, in order to do so. I was joking with a couple of the investors we were talking to today. I was like, you can Google how to troubleshoot an InfiniBand network and see kind of what comes up.
But, I think one of the other benefits, obviously, from an Ethernet standpoint is it is open standards. And that’s very important. It is also multi-tenancy. You think about carving up these large GPU clusters and wanting to share it amongst different customers. You kind of need multi-tenant aspects. So, I think that we see as these things start to scale, that’s where we see kind of that tipping point favoring Ethernet.
Simon Leopold
And maybe to follow-up is sort of what’s Arista’s differentiation because there is this sort of quandary of Ethernet’s a standard, that means we have got several vendors that support it. So how does a vendor like Arista do better with Ethernet than the other people also doing Ethernet?
Ita Brennan
Yes, I mean, Ethernet’s a standard to date too. So it’s all about — there, yes, there’s a standard, but then there’s also how performance and some products are, are better than others. I mean, for the same reason as we win at, say, 400 gig. If you think back to the 400 gig cycle, we had all of these discussions about how folks were going to come and take share and take some of our position with some of these customers. But in reality, the product was capable, was delivered on time, it executed well. Those things are not for nothing. So, everybody asks like, what if there’s more Ethernet competitors? A, it’s not easy, and B, we’re used to competing for this business.
Simon Leopold
I would argue incumbency counts. So if you are at an account with Ethernet, you’re more likely to stay at that account with Ethernet.
Ita Brennan
Yes. But there’s no denying that every one of these product cycles you need to bring, you have to bring your game, you have to bring your contribution from a roadmap perspective, from a technology perspective, and then you have to deliver really good products that scale. And there’s risk in that for us every time, but we’re hugely focused on that. If you lose sight on that of that, then that’s your exposure.
Simon Leopold
Now, last year’s analyst meeting, I think it was kind of an introduction or at least an introduction to the analyst group around this concept of transit wan, which was like, I think of Arista kind of spreading its wings, getting outside the data center. Can we get an update of where those opportunities stand, and how that sort of fits into the forecast?
Ita Brennan
Yes, I mean we do quite a bit of routing revenue at this point. Data center interconnect, we’ve reworked the software stack, if you like, the routing software stack for cloud so quite a bit of routing revenue with the cloud customers as well. And then, as we started to think about the enterprise space and the places where we were kind of had a gap in terms of the end-to-end solution that customers wanted and where customers were asking us to bring an EOS solution to bear. And that was one of those.
So, we’re early — it’s early days in terms of that deployment, but it would, but it’s very important to customers to be able to see where a product offering that will fill that gap. I mean, this analyst day, we talked about the NAC product. That’s the same idea, where are you introducing something that you really don’t need to introduce? If you can do it yourself, it’s core to the network, we think we can drive a solution there, but it is early. I mean, I think when we had talked about it last year, it was a concept. And so, we’re kind of close to full product now, but it’s going to take some time to start to see revenue from that.
Simon Leopold
So, I want to pivot to the, the campus part of the business. So you’ve reiterated your target 750 million by 2025, which is easy to confuse with the AI target because it’s the same. You should just pick two different numbers, so that we don’t get confused, but we won’t notice. But I want to reflect back a little bit on the strategy, because I think in the early days the strategy was you were going to be more software oriented and not get into sort of all these access points. And it looks as if you’ve sort of pivoted the strategy over time. You’ve kept the goals the same. Maybe before we sort of think about the outlook, I want to reflect what lessons did you learn in entering this business that’s different than sort of your core data center business?
Ita Brennan
Yes, so I don’t know that there was really a change in strategy or a change in fulfillment model. I think it was always our intention to sell the switches and sell the access points. And then maybe what’s different is for like, for an access point, really all of the value if you like, is in the management software, the management plane, which we run through CloudVision, right? And that’s still the case.
For the campus piece, it was very key obviously it was EOS, all the way through. And again, CloudVision was managing, if you had a data center, you could manage single image from your data from your routings or your data center through your campus, through to the Wi-Fi. So I think all of that has pretty much stayed the same. I think, if I think about surprises that we’ve had, I think we were surprised how much of the business is coming to us as campus first or campus only, right?
We had assumed that for the early stages for sure, we would be really using in our data center heritage and those customers to move into their campus solutions and that it would be harder to win campus only solutions. But we have seen a fairly balanced mix between new customers to us. So I think that’s been good. That that large enterprise, part of that campus market is there’s still a very dominant competitor there.
So, there are customers that are looking for an alternative to that either because of the technology, because of their experience, because of the fulfillment model that they’re driving. Lots of different reasons, right, but there’s definitely not a lot of competitors that play in that space. And so there is a real opportunity there to compete for campus only. And it’s nice to have a sometimes with a data center you have to wait a long time for a data center opportunity, but now you can insert with a campus opportunity and something else as well in one of those targeted accounts.
Simon Leopold
And can you talk a little bit about the go to market? You did mention targeting large enterprises, so I assume you win one deal, they’re relatively big deals rather than winning a 1,000 sort of small businesses. So probably a little bit easier on the channel, but what’s sort of your split between direct and where are you in terms of developing channel partners?
Ita Brennan
Yes, so I mean, we’re still — our primary kind of near term goal is to, is to target that large enterprise customer. And that’s the direct sale, right? And that’s where we keep adding salespeople, we can continue to get more coverage and add accounts there. They don’t necessarily pop in the same way you do a data center. It tends to be a big spend with a campus. You could do an initial campus and then another and another. So it’s a little different from a spend perspective.
If you think about the market, it’s about half of that including Wi-Fi, $40 billion market. About half of it is in that, maybe the less than half is in that large enterprise business part of the market. So that’s addressable that way. And then as you start to move down mid-market, that’s where the channel becomes much more important. So, I mean, we are adding channel partners. There’s a — I think there’s a relationship between how successful are you in the enterprise because it drives the brand.
Even though we don’t necessarily have the channel to sell for some of those opportunities, they would be fulfilling some of those opportunities. They could be doing services for some of those opportunities. So the more that you are present in the enterprise, I think the more that channel becomes easier.
But it is going to take time. Like there’s just no easy way to somebody’s asking us today, can’t you just turbo? But it’s going to take patience because there’s already some incumbents with large presence in the channel. So, we have to kind of find those channel partners as we go. But we’ve got partners now who probably would never have engaged with us three years ago, four years ago.
Simon Leopold
And I want to ask sort of a competitive landscape question, but I want to make it a little bit harder in that the easy answer is always like, we’re going to take share from Cisco. We get that. But when I think about the narratives from the bigger competitors like an HP Enterprise with Aruba Central and Juniper with Mist, they seem to have very similar strategies to Arista’s where it is large enterprise. It is taking advantage of Cisco’s weaknesses and complexity. So how do you compete against those kind of players?
Ita Brennan
I mean, it is interesting, again, when you look at that like large enterprise piece of the market, there still aren’t a lot. There is not a lot of share that’s going anywhere other than that key vendor in that large piece. There is still a lot of those players are still in that mid to maybe bottom of that large enterprise market. So our target is very much the big bet, large, enterprise customers to start with. But we do see the other guys sometimes, but it is largely against that one incumbent still. I mean, that’s where we are competing. Those are the opportunities that make the most sense for us right now. I don’t know, product wise, if you want to add anything.
Liz Stine
I mean, I think value prop wise, campus story isn’t really much different than the data center story. It is all about the quality of the OS, the operational efficiencies that you get with CloudVision, the visibility. And as the campus becomes more and more complex, and you think about campus isn’t just an office building any longer. It is a hospital wing. It is a hotel. There is so many more definitions of campus, and those networks are becoming more complex. Customers need a quality operating system. They need the tools in order to run these larger footprints and that we give it to them with EOS and CloudVision.
Simon Leopold
So do you have any certain long-term goals for this business because my recollection is, when you first announced it, there was sort of this aspiration of point being 10% of market undetermined time. But how do you sort of think about making it meaningful? Because it’s $750 million, you are clearly not done.
Ita Brennan
No. We would certainly hope not, not to be. Yes, I am not going to try and especially now that I am about to retire to pre-announce Jayshree’s target for campus beyond that. I think we’ll execute well against the 750 and then we will go from there.
Simon Leopold
So topic you and I have talked about before that I think is interesting in being different is your thoughts on a software strategy. In that so many companies in my sector have sort of pivoted towards software because you want to have a software model, you want to have recurring revenue, because that gives you a higher multiple. You don’t need a higher multiple. So you have had maybe a different take. But maybe help people understand how you think of the software business within Arista?
Ita Brennan
Yes, I mean, and we have thought about this a lot. Because, you see everybody around you doing something, you have to ask yourself, should you and why aren’t you? I mean, Arista is a software company. You that because 90% of the R&D resources we have are software people, right? I mean, it is a software company that’s what drives the capabilities of the product that customers are deploying. It happens to get sold with the switch.
We thought for a while, should we, in some way, take the core operating system, EOS and say, okay, we are going to sell this separately. But then what are you selling as a box? You are selling a box that doesn’t work, or you are going to sell a box that, the customer can use for a year, and then somehow it’s going stop working. It it was just a lot of friction with customers.
Large customers generally want capitalize their hardware and software together. They want to have a perpetual license. They want to buy it. And to us, honestly, the economics of it are not that different. These customers are smart enough to realize that if you do a subscription and it costs 50% more. It costs 50% more. There was really no substantive benefit from a business perspective. And if anything, it was just causing churn and friction for customers so we didn’t see that there was a need to do that, right?
But for offerings that are stand-alone value-add like CloudVision, like the visibility tools, the security products, those we sell as a subscription license, customers get to choose whether they buy it or not, it doesn’t hinder the switch from working. It’s there a decision if they see value and they can buy them. So those are software subscription licenses and we’re selling those. And you see those show-up a little bit in services and in the product revenue line.
Simon Leopold
How material is that within the business?
Ita Brennan
I think the last time we talked about it, it was kind of single digits. It has kept pace roughly with the business, which is not nothing given how we’ve been growing, right? But obviously, it gets dwarfed again by the product just because the product has been growing so fast. So, it’s a contributor to gross margin. These are very important offerings from a customer decision perspective from the strategic discussion with the customer, et cetera. But we still believe that taking EOS and trying to somehow artificially separate that is a bad idea. And really recurring revenue means I went at 40. I went at 100, I went at 400. I went that’s recurring revenue in our regimen.
Simon Leopold
Sure. Let me check with the audience if anybody’s got questions. If not, I’ve got plenty. Sure, we’ll repeat it.
Unidentified Analyst
[Indiscernible]
Ita Brennan
Yes. I mean, again, we don’t talk about the backlog, honestly. So I’m kind of not going to do that here. When you think about managing deployments, and we’ve talked about a little bit in the last filings that we’re still deploying things from those prior arrangements, and we’ll probably continue to do that into next year. That’s much I think as we’ve said about backlog.
Visibility is obviously, we’ve talked about visibility shortening, visibility has shortened. So I think by the end of the year, you’re somewhere. Is it normal? If you think back to pre-COVID, we were turning business in a corner, right? So we will end up having some flexibility to turn business in the quarter again here before too long. But we’ll definitely have some extension of kind of the lead times overall and the visibility overall from that?
Simon Leopold
So I always like to close with the same question, which is what do you think is the least appreciated aspect of the Arista story?
Ita Brennan
Yes. I mean, I think it comes back to just how powerful these two businesses inside one can be, right? And we have to continue to execute on it. But this cloud business that is — these are amazing customers who are growing like investment and growing revenues on a huge base, right? And they continue to do that and they can continue to do that. That’s one piece of the business, put it cyclical and maybe it has lower gross margins, but pretty healthy operating margin still.
And then you have the campus piece of the business, which if you do that right, you can continue to grow that. It’s a much more steady grower. It has higher gross margins. It has a nice offset on the gross margins, and it’s still a very healthy operating margins. I think the value and power of having those two solve some of the kind of things that you worry about in the business model over time.
Simon Leopold
Liz, Ita, thank you very much for joining us folks, joining our session with Arista Networks.
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