Arista Networks Inc (ANET) — Q2 2023 Earnings Call Transcript

Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me on today's call are Jayshree Ullal, Arista Networks’ President and Chief Executive Officer, and Ita Brennan, Arista's Chief Financial Officer. This afternoon, Arista Networks issued a press release announcing the results for its fiscal second quarter ending June 30, 2023. 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 third quarter of the 2023 fiscal year, longer-term financial outlooks for 2023 and beyond, our total addressable market and strategy for addressing these market opportunities, including AI, customer demand trends, supply chain constraints, component costs, manufacturing output, inventory management, and inflationary pressures on our business, lead times, product innovation, working capital optimization, and the benefits of acquisition, which are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically, in our most recent Form 10-Q and Form 10-K, and which could cause 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.

Thank you, Liz, and happy last day of July, everyone. We delivered revenues of $1.46 billion for the quarter with a non-GAAP earnings per share of $1.58. Services and software support renewals contributed approximately 15.2% of revenue. Our non-GAAP gross margins of 61.3% were influenced by improving supply chain overheads and higher enterprise contribution. We do expect gross margins to consistently improve every quarter this year and stabilize in 2024. International contribution registered at 21%, with the Americas at 79%. As we surpass 75 million cumulative cloud networking ports, we are experiencing three refresh cycles with our customers: 100 gigabit migration in the enterprises, 200 and 400 gigabit migration in the cloud, and 400 going to 800 gigabit for AI workloads. During the past couple of years, we have enjoyed a significant increase in cloud CapEx to support our cloud titan customers for their ever-growing needs, tech refreshes, and expanded offerings. Each customer brings a different business mix of AI networking and classic cloud networking for their compute and storage clusters. One specific cloud titan customer has signaled a slowdown in CapEx from previously elevated levels. Therefore, we expect near-term cloud titan demand to moderate, with spend favoring their AI investments. We do project, however, that we will grow in excess of 30% annually versus our prior Analyst Day forecast of 25% in 2023. The AI opportunity is exciting. As our largest cloud customers review their classic cloud and AI networking plans, Arista is adapting to these changes, thereby doubling down on our investments in AI. Arista is a proud founding member of the Ultra Ethernet Consortium that is on a mission to build open, multi-vendor AI networking at scale based on proven Ethernet and IP. There are a lot of software and EOS considerations for AI. AI traffic and performance demands are different as it comprises a small number of synchronized high-bandwidth flows, making them prone to collisions that slow down the job completion time of AI clusters. As they connect thousands of GPUs, generating billions of parameters for petascale cloud clusters, Arista's EOS capabilities must also scale along with our AI spine and leaf platforms to achieve that consistent performance and throughput. Arista has been developing EOS features such as intelligent load balancing and advanced analyzers to report and rebalance flows that can achieve predictable performance. Customers can now pick and choose programmable packet header fields for better entropy and efficient load balancing of their AI workloads. Network visibility is also important in the training phase for large datasets to improve the accuracy of large language models. Arista's new AI Analyzer monitors and reports traffic counters at microsecond-level windows to detect and address microbursts. Our AI strategy and platforms are resonating well with our early customers. Presently, in tech 2023, we are in the middle of trials for back-end AI networks, leading to pilots in 2024. We expect larger clusters and production deployments in 2025 and beyond. In the decade ahead, AI networking will become an extension of cloud networking to form a cohesive and seamless front-end and back-end network. In the non-cloud enterprise category, we continue to experience good momentum in both data centers and campuses. Let me illustrate with a few customer wins. The first is an international new classification win where the customer was seeking to modernize their legacy campus. Their endpoints included large and small campus locations, internal communication devices, various IoTs, CCTV, display boards, and much more. The customer mandated a fully automated workflow. Arista presented a highly optimized best-of-class cognitive campus where there is a single binary EOS image across all campus platforms, complete with a universal API and built-in automation features. The customer was set on a path to continued campus modernization. The next enterprise win involves both data center and campus with advanced EVPN L3 VPN over VXLAN routing architectures instead of the traditional Layer 2 extension. Distributed AVA sensors were strategically positioned within the network to capture and analyze traffic at critical points. This zero-trust approach emphasizes strict mitigation throughout the network as opposed to relying solely on silo security. The integration of real-time streaming telemetry and visibility capabilities proved to be paramount in obtaining this operational acceptance. The final win was in a large public sector, connecting redundant data centers to hundreds of campus locations with a large routing environment. They were challenged with complex MPLS routing that was hard to operate across the WAN and campus network. An upgrade of any magnitude implied several million dollars, impacting change controls to touch on all their sites. Arista demonstrated that the customer could use a single spine for both LAN and WAN to dramatically simplify and automate the whole environment within 30 days. This 80% reduction in total cost of ownership was made possible with Arista's modern cloud operating model. You can see a recurring theme here across all these customer wins, which is the power of our platform innovation, quality, and support with a low TCO and a single cloud vision and EOS software stack. Arista is diversifying its business to transform the enterprise into a modern network operating model. Before I hand it to Ita, I would like to share with you that Ita is planning to retire sometime next year in 2024. She has had a stellar career at Arista as our Chief Financial Officer. Ita has been our business partner and friend for the past eight years. She has displayed the Arista way, always prioritizing our customers, employees, and shareholders. Ita has demonstrated and delivered both growth and profitability with very little G&A investment, often only 1.5% of revenue. These types of pristine financials are so rare in a fast-growing tech company and only possible with a shared vision between the CFO and CEO. Ita, thank you for your steady leadership and contribution. Undoubtedly, we will miss you next year when you retire. Over to you for financial metrics.

Thanks, Jayshree. That’s very kind. It’s been an amazing experience working with you and the whole Arista team over the last eight years. Now back to the numbers. This analysis of our Q2 results and our guidance for Q3 is based on non-GAAP and excludes all non-cash stock-based compensation impacts, certain acquisition-related charges, and other non-recurring items. A full reconciliation of our selected GAAP to non-GAAP results is provided in our earnings release. Total revenues in Q2 were $1.46 billion, up 38.7% year-over-year and well above the upper end of our guidance of $1.35 billion to $1.40 billion. Services and subscription software contributed approximately 15.2% of revenue for the quarter, up from 14.9% in Q1. International revenues for the quarter came in at $304.4 million or 20.9% of total revenue, up from 17.5% last quarter. This quarter-over-quarter increase largely reflected a healthy contribution from our enterprise customers in EMEA and APAC and some reduction in domestic shipments to our cloud titan customers, which were unusually robust in the prior quarter. Overall gross margin in Q2 was 61.3%, in line with our guidance of approximately 61% and up from 60.3% last quarter. We continue to see incremental improvements in gross margin quarter-over-quarter with higher enterprise shipments and better supply chain costs, somewhat offset by the need for some additional inventory reserves as customers refined their forecasted product mix. Operating expenses for the quarter were $287.3 million or 19.7% of revenue, up from last quarter at $257.5 million. R&D spending came in at $188.5 million or 12.9% of revenue, up from $164.8 million last quarter. This primarily reflected increased headcounts and higher new product introduction costs in the period. Sales and marketing expenses were $79.6 million or 5.5% of revenue compared to $75.9 million in the last quarter with increased headcount and product demo costs. Our G&A costs came in at $19.1 million or 1.3% of revenue, consistent with last quarter. Our operating income for the quarter was $606.5 million or 41.6% of revenue. Other income and expense in the quarter was a favorable $31.6 million, and our effective tax rate was 21.4%. This resulted in net income for the quarter of $501.2 million or 34.4% of revenue. Our diluted share number was 316.5 million shares, resulting in a diluted earnings per share number for the quarter of $1.58, up 46% from the prior year. Now turning to the balance sheet. Cash, cash equivalents, and investments ended the quarter at approximately $3.7 billion. In the quarter, we repurchased $30 million of our common stock at an average price of $137.2 per share. We've now repurchased $855.5 million or 8 million shares at an average price of $107 per share under our current $1 billion Board authorization. This leaves $145 million available for repurchase in future quarters. The actual timing and amount of future repurchases will be dependent on market and business conditions, stock price, and other factors. Now turning to operating cash performance in the quarter. We generated approximately $434.1 million of cash from operations in the period, reflecting strong earnings performance, partially offset by ongoing investments in working capital. DSOs came in at 49 days, down from 57 days in Q1, reflecting a strong collections quarter with good linearity of billings. Inventory turns were 1.2 times, down from 1.3 times last quarter. Inventory increased to $1.9 billion in the quarter, up from $1.7 billion in the prior period, reflecting the receipt of components from our purchase commitments and an increase in switch-related finished goods. Our purchase commitments at the end of the quarter were $2.2 billion, down from $2.9 billion at the end of Q1. We expect this number to continue to decline in future quarters as component lead times improve, and we work to optimize our supply position. Our total deferred revenue balance was $1.085 billion, down from $1.092 billion in Q1. The majority of the deferred revenue balance is services-related and directly linked to the timing and terms of service contracts, which can vary on a quarter-by-quarter basis. Our product deferred revenue balance declined approximately $33 million from last quarter. Accounts payable days were 57 days, up from 55 days in Q1, reflecting the timing of inventory receipts and payments. Now turning to our outlook for the third quarter and beyond. To recap, global supply chain disruptions over the last couple of years necessitated elongated planning horizons and customer demand signals. The crawler results are true, improving lead times and now driving shorter planning horizons and demand signals, delaying when customers need to place new orders. This is particularly true of our cloud titan customers who, following a year of elevated purchases, are now rapidly changing technology roadmaps and priorities before providing visibility to future demand later in the year. On the supply side, we expect to continue to ship against previously committed deployment plans for some time, targeting supply improvements where most needed, but also careful not to create redundant customer inventory. In spite of the return to shorter lead times and reduced visibility, we are executing well with gradual incremental improvements to our 2023 outlook, which now calls for year-over-year growth in excess of 30%. On the gross margin front, we expect continued progress through the end of the year, reflecting supply chain and manufacturing benefits while maintaining a reasonably healthy cloud contribution. Now turning to spending and investments. We continue to monitor the overall macro environment carefully. We'll prioritize our investments as we move through the year. This will include a focus on targeted hires in R&D and go-to-market as the teams seek the opportunity to add talent. On the cash front, while we'll continue to focus on supply chain and working capital optimization, you should expect some continued growth in inventory through the end of the year. Also, as a reminder, our 2023 tax payments have been deferred to October and will represent a significant use of cash in that quarter. With all of this as a backdrop, our guidance for the third quarter is based on non-GAAP results and excludes any non-cash stock-based compensation impacts and other non-recurring items as follows: Revenues of approximately $1.45 billion to $1.50 billion, gross margin of approximately 62%, operating margin at approximately 41%. Our effective tax rate is expected to be approximately 21.5%, with diluted shares of approximately 318 million shares. I will now turn the call back to Liz.

Thank you, Ita. We will now move to the Q&A portion of the Arista earnings call. To allow for greater participation, I'd like to request that everyone please limit themselves to a single question. Thank you for your understanding. Operator, take it away.

Hey, this is Mike Ng from Goldman Sachs. Thanks for the question. I was just wondering if you could talk a little bit more about the outlook for in excess of 30% year-over-year growth this year on revenue? What's gotten better relative to the last earnings call? If you could talk about it in the context of cloud titans versus enterprise, that would be helpful. I'm just trying to reconcile the revenue upgrade versus the commentary about near-term cloud titan growth moderating. Thank you.

Yeah. Thanks, Mike. I think it's pretty clear that from quarter-over-quarter, our enterprise momentum continues to get stronger and better. And our cloud is strong. However, it's got two components now. There's the classic cloud networking and then the AI. So we're reconciling how we double down more on AI, which we are feeling stronger and stronger about. And even on the cloud, you know that the last two years have just been out of this world and phenomenal. So while it's moderating, it’s still pretty good.

Thanks, Mike.

Thank you. Jayshree, I was hoping you could dig more into some of the comments around AI. It sounds like there's a large pipeline there, and you talked about kind of the stages with 2025 being the big growth area. I'm curious if you can just talk a little bit about a few things related to that. One, do you see that the move to AI expanding or diversifying more your cloud titan or your cloud customers? And second, can you talk about kind of the next year or two in the entire InfiniBand versus Ethernet debate? I think you guys have been trialing some Ethernet inside clusters. Can you just give us an update on how you think that competition between those two technologies is going to play out? Thank you.

Okay. Thank you, Tim. Maybe my answer will be shorter than your question. But I think the gist of what I'd like to, first of all, say is the majority of Arista's participation has been in the front end of the network. Right? And we're getting a chance for the first time ever to play in the back end. So when we think AI, there's clearly some ramifications of bandwidth on the front end of the network, but we're not counting that. So we're truly thinking of something that's incremental, brand new, a lot of work to do in testing, proving, pilots, trials before we get into production. Today, I would say in the back end of the network, there are basically three classes of networks. One is very, very small networks that are within a server where customers use PCIe, CXL. There's proprietary NVIDIA-specific technologies like NVLink that Arista does not participate in. Then there's more medium clusters, you can think generative AI mostly and inference, where they may well get built on Ethernet. For the extremely large clusters with large language training models, especially with the advent of ChatGPT-3 and ChatGPT-4, you're not talking about billion parameters, but an aggregate of trillion parameters. And this is where Ethernet will shine. But today, the only technology that is available to customers is InfiniBand. So, obviously, InfiniBand with 10, 15 years of familiarity in an HPC environment is often being bundled with the GPUs. But the right long-term technology is Ethernet, which is why I'm so proud of what the Ultra Ethernet Consortium and a number of vendors are doing to make that happen. So, near-term, there's going to be a lot of InfiniBand, and Arista will be watching that outside in. But longer term, Arista will be participating in an Ethernet AI network. And, neither technology, I want to say, was perfectly designed for AI. InfiniBand was more focused on HPC and Ethernet was more focused on general-purpose networking. So I think the work we are doing with the UEC to improve Ethernet for AI is very important.

Okay. Thank you. That's very helpful.

Great. Thanks. Just revisiting kind of the cloud titan commentary, does the change that you're seeing mean that they're completing kind of one upgrade cycle? There might just be time between the next upgrade cycle or are there real changes to kind of current deployment plans or kind of deployment of the current upgrades? Thanks.

Yeah. Sorry.

Sorry. Meta, were you addressing the question to Ita?

I guess I was addressing to whoever wants to answer about the commentary on the changes in the cloud titan order.

Go for it, Anshul.

Sure. Meta, when you look at the cloud customers, in the last few quarters, especially since the advent of ChatGPT, there’s been a rotation into AI. It's not that they're done with the upgrades or this is one of the upgrades, but they had to reprioritize their business and their deployments for AI. You've seen the competitive battle between the largest titans in the world trying to get ahead. But we see signs of that slowing. And in the future, we believe they'll be back to adding and refreshing the standard computer infrastructure as well.

I always say that for so long eventually you have to eat. So I think we will see a nice mix of AI and classic cloud networking over time.

I believe that the improvements in lead times have allowed them to wait longer than we're used to in recent years. However, we will soon be aligning with lead times, and then we'll see what happens.

Thank you.

Thanks, Meta.

Good evening, everyone. Thank you for the question. Ita, congratulations. I wanted to ask you about the current lead times. You mentioned taking a more managed approach to inventory levels at customers. Could you share some strategies you use to manage that and what your thoughts are on inventory levels within those accounts? Thank you.

Yeah. I think, look, the lead times are mixed across products. I mean, our goal certainly is to try to get back to, like, a six-month lead time here, maybe the end of the year or certainly early next year. But I think it is currently mixed across products. The commentary around customer inventory itself, we've been very diligent all the way through this process, the supply chain process of trying to make sure we understood demand when it showed up and that it was being put into reasonable deployment schedules and deployment plans. And we just want to continue to do that as we come through the other side of really that whole supply chain disruption. So it's really more about understanding kind of what customers need, when they need it, and, again, being able to prioritize and make sure that we understand that. So, it's really a continuation of what we are doing, honestly, on the other side of the supply chain when you have this accelerated demand, and now we are very focused on deployment schedules and timing. And this is just the other side of that. Again, making sure we understand what's happening.

Thank you.

Hi. Thanks a lot for taking my question. A little bit of a longer-term question, but can you please provide an update on the opportunity at hyperscalers beyond your two largest customers? Does the accelerated deployment of AI clusters potentially open the door to business with the other two hyperscalers as the complexity of the network is increasing rapidly?

So this gets asked very often, how we're doing that, and we continue to do well with them. As I mentioned before, not all titans are the same in terms of size. Some are small and we do very well with them, but they're just not as big as our two largest customers. And others who have the potential, we're still doing very well technologically with them but we haven't seen the opportunity materialize. It’s not that we're losing to anybody. It's just nothing has changed. And we continue to invest with them, and we believe the opportunity is still ahead of us.

I believe our AI opportunity is looking ahead to the next ten years. We will have early customers in the cloud with substantial datasets testing our Ethernet. Over time, more cloud customers, not just the largest ones, but also other significant Tier 2 cloud providers and enterprises with large datasets, will also test our offerings. By 2025, I anticipate having a considerable list of customers, with the largest cloud companies still being among them, but not the only ones.

Thanks, Antoine.

Hello. Yep. Thanks, and congrats on a nice quarter here. I guess my question is really, there's been a fair bit of debate, I mean, investors on what does calendar '24 look like for Arista. And the fear, always, it could look like calendar '20 when you had some cloud digestion. I realized it's really early for you to guide '24, but if you just sort of think about the puts and takes into next year, that would be helpful. And maybe, Jayshree, you could talk about how do you think Arista is different today versus in the calendar ’19 and the ‘20 time frame, that would be helpful?

Yeah. That's a really good question. Stay tuned for our 2024 guide when we have our Analyst Day sometime in November. But qualitatively speaking, we're a very different company today than three years ago. Clearly, we've doubled down on our cloud titans, and you'll see that they're getting stronger and stronger. But even in the cloud titans, Anshul and the team have worked to have a number of use cases. It isn't just one. And the addition of AI to that use case just gave us a whole lot of broad opportunity from front end to back end. Right? So to me, the holistic and seamless and cohesive between the front end and back end will get even more important as time goes on in cloud titans. We also see that we're stronger in Tier 2 providers and, of course, the broader enterprise. Both of these weren’t as strong for us three years ago, and they also represent AI opportunities, but as you know, they represent campus, routing, classical data center opportunities, and allow us to target a much larger TAM. Again, three years ago, it was probably $30 billion. Three years later, it's well north of $50 billion. So I feel we are much more diversified, and while we deeply appreciate our major customers, we have a lot more opportunities beyond that.

Thank you, Amit.

Hi, Ita. I need to ask you a challenging question before you leave, hoping for good days ahead. How much of the current growth is due to backlog drawdown? Can you provide insights on order trends instead of revenues? The reason I'm inquiring is that your guidance for Q3 indicates 25% growth, while for Q4, it's just an implied 11%, suggesting a significant slowdown in growth in Q4. I'm curious if this is related to the conclusion of the elevated backlog. Thank you.

We haven't really discussed backlog and orders; instead, we've focused more on deployments and deployment slots. Looking back at my previous comments, we believe there will be ongoing deployments extending into 2024. I don't fully agree with the terms like backlog or drawdown. While it's challenging to avoid that terminology based on order patterns, I want to emphasize that we have deployments already planned for 2024. We're evaluating things on a quarterly basis through the end of the year, but I still support an incremental approach and expect to show improvements as we head into Q3. For Q4, we anticipate similar incremental improvements, which is the approach to keep in mind for now. However, our remarks regarding demand and lead times remain unchanged.

Tal, this is Jayshree. I know your question is challenging. We'll have more clarity as time progresses. We believe the business remains strong, whether that strength manifests in 2024, 2025, or somewhere in between, we'll see. However, it will be tough to replicate the exceptional cloud CapEx performances we saw over the past two years for cloud networking. As deployments continue and we focus on AI, alongside the enterprise and Tier 2 clouds, we have a good mix of opportunities. I encourage everyone to view our business, as Ita has pointed out, over a three-year compound annual growth rate rather than just one quarter or year. I anticipate our three-year CAGR will stay in the double digits with favorable figures.

Great. Thank you.

Thanks, Tom.

Great. Thanks for taking the question. Can you maybe just update us on the visibility in your customer base? Is it still around six months, or are we now down closer to three months? And maybe just longer-term, do you think that generative AI could help improve that visibility from where it's historically been just given that many of these hyperscalers have what seems like decent visibility into a pretty robust pipeline over the next few years?

That's a really good question. Since we have many products in the mix, I need to break your question into visibility across several areas. For enterprise, I would say visibility is generally six to twelve months. In the cloud, due to the reduced lead times on classic cloud networking, it's less than six months. However, for AI, the timeline is longer since it's still in the early stages and requires more joint development. So you can think of it as three migrations happening simultaneously, each with different visibility patterns.

Hi, thanks for taking my question. Maybe if I can shift gears here a bit to enterprise, Jayshree. And obviously, you're talking about the slowdown on the cloud side here a bit going into 2024. But when you look at enterprise, how do you think about sustaining a growth rate or the slowdown in that growth rate into 2024? What are you seeing in terms of orders on that front to sort of give you visibility into 2024? Thank you.

Look, I think this scenario that we feel pretty good about. And it's an area of great execution from Anshul, Chris Schmidt, Ashwin, and the entire team, where we have really diversified our business globally in the enterprise. We're not just in the high-end financials. We're in just about every major vertical: healthcare, transportation, public sector, education, banks, insurances. So I feel enterprise, barring any macro issue, which is the thing we worry about for 2024, if the macro doesn't let us down and you don’t have to worry about the economy, we will have a strong year in enterprise.

Thank you.

Yeah. Thank you for taking the question. I guess I wanted to ask just on product cycle cadence. There's a lot of focus from one of your key component suppliers in the merchant silicon side around 51.2 terabit silicon, and obviously supporting the 800 gig cycle. I'm curious, how do you think about the timing of that? When do we start to see the materializing deployments of 800 gig and maybe that's tied to AI, maybe it's not, but just curious of when that cycle you believe really starts to kick in?

Aaron, we had the same discussion when the world went to 400 gig, switching from 100 gig to 400 gig. The reality was customers continue to buy both, 100 gig and 400 gig for different use cases. 51T and 800 gig especially are being pulled by AI clusters; the AI teams are very anxious to get their hands on it, move the data as quickly as possible, and reduce the job completion times. So you'll see early traction there. You'll see, as we mentioned, trial studies in '24 going into volume in '25. And that should be the ramp we'll follow for 800 gig. But that does not mean everything they just bought last few years at 400 gig for DCI or the spines and so on for classic clusters are going to get upgraded to 800 gig. I think that's going to be a longer cycle. So you will see 100, 200, 400, and 800 being deployed in parallel as we enter that cycle in '24, '25.

Thank you.

Thanks, Aaron.

Hey, thanks for taking the question. I'm just wondering on the supply chain, if you can talk about how that's evolved over the last quarter? And as it relates to gross margin, I think you're messaging incremental improvements in Q3 and Q4. Is that purely a function of easing supply chain, or is there also maybe greater relative contribution from enterprise relative to cloud titans envisioned in the second half of the year as well? Thanks.

I mean, we're definitely seeing improvement on the supply chain side. We're seeing improvements with freight, improvements with just some of the expedite costs and the things that we were dealing with and we're kind of inventoried and now we're releasing them. So I think we're coming out from underneath that. There is some small shift in mix as well, but it's still a good strong cloud mix this quarter, this year. So, it's not like we're back to a heavy enterprise mix without creating a much smaller part. There's still a very healthy cloud mix in this year. So it's more where we can back out our supply chain stuff that we incurred in the past.

Yeah. I want to give a shout out to Mark Brillhart, our new Senior VP of Manufacturing, and John McCool, both in Anshul's team, have done a fantastic job of optimizing the supply chain. So those improvements are really playing a role in our quarter-to-quarter gross margins.

Thank you.

Hey, thanks for the question. I just wanted to follow up around some of the prior questions asked as many might have been asked already. But I know you guys aren't talking about visibility and don't discuss backlog, but is it still fair to assume that we should think about you guys returning to a normal environment from a supply perspective in the early part of next year? And I believe, Ita, you talked about, underneath assuming that hyperscalers or your cloud titans grow double digits for this year. Is it still fair to think about that kind of level for 2023?

Yes. I think it’s absolutely right? And I think that we kind of forget that cloud is still an important part of 2023. Right? We're still executing on deployments and planning that we did some time ago, right, all the way through this year. So cloud is still a significant piece of the business in 2023.

Yes. And, James, just to confirm, we expect a more normal setting in 2024 in terms of lead times. You're right to assume that.

Thanks, James.

Thanks for taking the question. I wanted to see if you could maybe do a little bit of unpacking in terms of what's driving your enterprise business in that I think the conventional wisdom is that enterprises are challenged by recessionary forces on the cycle, and then the secular challenge around public cloud adoption need slowing. So what do you see happening? How much of this success is related to market share gains? How much to general cycles, products, et cetera? If we could unpack the enterprise traction. Thank you.

Sure, Simon. We are indeed seeing gains in market share, which stem from our success in the enterprise sector. The main reason for our success is that our customers have lacked a high-quality, supportive software experience for quite some time. They have not experienced a unified architecture across their data centers and campus routing in years. The shift towards a modern cloud operating model in the enterprise is the leading factor in why Arista is being chosen. Customers are looking for our architecture to provide that quality experience. Anshul and I discussed how we often use the term "cloudify," which can be complex. High-end enterprises are eager to adopt cloud principles, but they also want those principles to work on-site. The transition of workloads between the cloud and the enterprise varies by customer. Some mid-market customers prefer to shift their e-commerce operations to the cloud, while many of their essential applications remain on-premises. Our hybrid strategy continues to influence data center decisions. Additionally, our expansion into campus routing, zero-trust security, and observability is enhancing our offerings. Our product range is becoming increasingly robust. We've been focusing on the cloud operating model and product depth for around three to five years now, especially in the United States, though we still have work to do internationally. I recall a conversation with Ita about five years ago where she convinced me to increase our investments in the enterprise. All these factors have shaped us into a leader in the enterprise space, and we have established ourselves as a gold standard with a significant presence in that arena.

Thank you, Simon.

Great. Thanks, guys, for taking the question, and congratulations, Ita. I just want to go back to the point of maybe help bridge the '23 to '24 to '25 commentary that Jayshree mentioned sort of strong double-digit growth. I think in the past you've talked about 15% growth across cycles. And I'm just trying to think through, is there enough in trials and pilots in '24 to kind of get you to that kind of mid-teens growth over the next couple of years? And if not, does that mean that your enterprise business has to remain incredibly robust in '24, upwards of high-teens to low 20% growth next year? I know you're not giving guidance. But trying to kind of walk the bridge to get from where we are today to '25 where you're going to start to see more widespread AI deployments from a revenue recognition perspective. Thanks.

So, now you want to go to '25 as well. I don't think we're ready to do that. But that's a really good conversation for the Analyst Day honestly. I think we obviously are very focused internally. As Jayshree reiterated earlier on, the business is a lot more robust with many different drivers. As you go through that period, cloud will ebb and flow, but it's still a healthy business. It has been a healthy business through those cycles. So, I think we've got a lot of the building blocks, but how we're going to assemble them, maybe we'll save for the Analyst Day.

We'll share the legal plan more. But David, rest assured that we are aiming for at least double digits next year. And so, we'll go from there.

Great. Thanks, guys. And congrats, again.

Thank you.

Yeah. Thanks for taking the question. Maybe this is for Anshul. Can you just walk us through kind of how the cloud titans work? We hear a lot about them buying volumes of GPUs right now. At what point do their purchasing of GPUs translate into their demand for switches? How does it work with the trials and so on and so forth?

Sure. There is no uniform recipe, but in general, when they're buying GPUs, they typically need additional infrastructure to connect. These could be off few quarters depending on their timing of deployments until they build the network out for very large things. But it takes a couple of months sometimes, or a quarter or more, to fine-tune the cluster and benchmark and test everything before it is actually released to production. So, you can think of that as the basis, a couple of months, a couple of quarters minimum before you can get there. Sometimes it adds up to about a year before you really ramp into production.

Great. Thanks, Erik.

Hi, guys. Thanks a lot. I guess I wanted to ask about your comments about 2025 participation in AI. Could you walk us through sort of the milestones that you see between now and then in terms of increasing Arista's participation? Certainly, there is new product development, there is market acceptance, I presume. And then also I assume that you participate today with inferencing applications and that's by and large done on Ethernet. I think what we're really talking about is training, correct? So any more color there would be great. Thanks.

Yes, George. So, I think you can look at 2023 as really a year of planning for AI, because as I said, there's tons and tons of GPUs being purchased. And then the question is how is it being connected. So, depending on whether they are small, medium, or large, there are different technologies, but I'm going to stay focused on the large because that's the biggest problem. You are right to say some of them may use Ethernet or even a non-networking technology, just an IO or a bus for smaller networks. But generally speaking, we're focusing on things that are much larger than 200 or even 1,000 GPUs. So that's the first thing. So, a lot of planning is going into that. The planning basically is how do they get the GPUs, what is their application, what is the size of the cluster, what is the time, what are the large language model datasets, et cetera, and what is their network foundation? In some cases, where they just need to go quick and fast, as I explained before, it would not be uncommon to just bundle their GPUs with an existing technology like InfiniBand. But where they're really rolling out into 2025, they're doing more trials and pilots with us to see what the performance is, to see what the drop is, to see how many they can connect, what's the latency, what's the better entropy, what's the efficiency, et cetera. That's where we are today. Now, we expect next year this will translate to some, what I call, pilots, because the majority of them will happen in '25, but in '24, you'll start seeing, what do you say, Anshul, maybe 4,000 to 8,000 GPUs, something like that?

That's right. In that range.

We expect to deploy between 4,000 to 8,000 GPUs with around 400 gig type clusters, initiating some production workloads. We refer to these as smaller pilots. However, the real test comes in 2025 when we aim for not just 4,000 to 8,000, but potentially 30,000, 50,000, or even 100,000 GPUs. This makes 2025 a critical year. It's vital to test and iron out any issues with the GPUs and networks, as a strong network is essential for maximizing GPU performance. If we experience idle cycles on these GPUs, we risk wasting thousands, if not millions, of dollars. Therefore, the next two years are key to optimizing the use of these costly GPUs, highlighting the importance of the network. Anshul?

If I can add one more thing here, what are the milestones to get to these 2025 deployments, there is one key milestone. That has nothing to do with GPUs or our switches, which is does the customer have enough power and the site ready to deploy that many megawatts or gigawatts of capacity. And as you know, getting a 1,500-megawatt site takes a couple of years, which is why this is a floor ramp. This does not certainly turn on the key and you have thousands of GPUs.

Yeah, really good point. Simple things like power and space are still vital.

Thanks, George.

Yes. Thank you. Jayshree, there's been some investor concern that hyperscale customers may focus more on white box solutions for 800 gig WAN in the 400 gig cycle. We're aware that some of your customers continue to adopt a dual-sourcing strategy. But if you could just comment on the potential for an upgrade cycle as well as reuse risk on the transition to 800 gig, it will be very helpful. Thank you.

Sure. As you're probably well aware, the white box question has remained with Arista as one of the most popular questions asked right from the time of our IPO, whether it's a 10 gig, 40 gig, 100 gig, 400 gig, or now you ask it at 800 gig. I think there will always be an element of white box if somebody is just looking to build something and throw in some quick traffic. But for some of these most mission-critical networks, it's less about the box and more about the software stack and how much performance availability and power you really get out of this. So, the cost of putting in the box, if you save something, if you even save something, is far dwarfed by the total OpEx you need to make that box work. So, we continue to believe that we will coexist with white box in some of our cloud titan customers. We will continue to run both SONiC and FBOSS in the case of Microsoft and Meta along with our EOS. But at the end of the day, whether it's a white box or a blue box, it's the software stack that really wins.

Thanks, Karl. Operator, we have time for one last question.

Hey, thanks a lot for sneaking me in there. Congratulations, Jayshree and team. I wanted to ask about enterprise again. I think the comments you made around cloud titans were all things that people were able to detect, but the enterprise just seems so much better in terms of the performance and the guide. So, you mentioned that you gained share, but did the market pick up as well? And did you see that market pickup in demand in the enterprise sustaining into '24? And just kind of more color around enterprise and whether the market picked up in addition to you gaining share.

Hey, Ben. Thank you. What do you mean by the market pickup? I don't follow the question.

Did demand pick up? Because the enterprise outperformance was quite a surprise, and clearly the cloud titan commentary was subdued as everybody was able to predict after the last conference call this week. So, I mean, was it all market share or is the market picking up? Is demand picking up across the board?

I would say to you that probably our enterprise demand has always been strong and not subdued, far from that, however, dwarfed by the excellence of our cloud performance. You didn't notice it, and now you're noticing it.

This concludes the Arista Networks second quarter 2023 earnings call. We have posted a presentation which provides additional information on our results, which you can access on the Investor section of our website. Thank you for joining us today and thank you for your interest in Arista.