Yahoo Finance Arista Networks, Inc. (NYSE:ANET) Q4 2023 Earnings Call Transcript
Arista Networks, Inc. (NYSE:ANET) Q4 2023 Earnings Call Transcript February 12, 2024
Arista Networks, Inc. beats earnings expectations. Reported EPS is $2.08, expectations were $1.71. Arista Networks, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Welcome to the Fourth Quarter 2023 Arista Networks Financial Results Earnings Conference Call. During the call, all participants will be in a listen-only mode. After the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time. [Operator Instructions] As a reminder, this conference is being recorded and will be available for replay from the Investor Relations section at the Arista website, following this call. Ms. Liz Stine, Arista's Director of Investor Relations, you may begin.
Liz Stine: Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me on today's call are Jayshree Ullal, Arista Networks' Chairperson and Chief Executive Officer; Ita Brennan, Arista's outgoing Chief Financial Officer; and Chantelle Breithaupt, Arista's incoming Chief Financial Officer. This afternoon, Arista Networks issued a press release announcing the results for its fiscal fourth quarter ending December 31st, 2023. If you'd like a copy of this release, you can access it online from 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 first quarter of the 2024 fiscal year, longer-term financial outlooks for 2024 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 acquisitions, which are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically in our most recent Form 10-Q and Form 10-K and which could cause actual results to differ materially from those anticipated by these statements.
These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future. 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.
Jayshree Ullal: Thank you, Liz. Thank you, everyone, for joining us this afternoon for our fourth quarter 2023 earnings call. 2023 has been another memorable year for Arista. We gave initial guidance of 25% year-over-year revenue growth and instead achieved well beyond that at 33.8%, driving revenue to $5.86 billion, coupled with a record non-GAAP earnings per share for the year of $6.94, up in excess of 50% annually. Back to some Q4 specifics. We delivered revenues of $1.54 billion for the quarter, with a non-GAAP record earnings per share of $2.08 due to a one-time favorable tax rate. Services and software support renewals contributed approximately 17% of revenue. Our non-GAAP gross margins of 65.4% was influenced by improving supply chain and greater enterprise mix.
International contributions for the quarter registered at 22.3%, with the Americas at 77.7%. This was one of our strongest-performing international quarters in recent history. Shifting to annual sector revenue for 2023. Cloud titans contributed significantly at approximately 43%. Enterprises, including financials was strong at approximately 36%, while the providers were at 21%. Both Meta and Microsoft are greater than 10% customer concentration at 21% and 18%, respectively. Despite multiple CapEx reductions last year and the normal volatility of cloud titan and AI pivot, we cherish our privilege status with both M and M. Speaking of AI, in fall of 2023, Andy and I attended the 50th golden anniversary of Ethernet at the Computer History Museum.
It truly is a reminder of how familiar and widely deployed Ethernet is with the speed increasing by orders of magnitude from a shared collision 2.95 megabits for file printed share to a terabit Ethernet switching in the AI and ML era. AI workloads are placing greater demand on Ethernet, as they are both data and compute-intensive across thousands of processes today. Basically, AI at scale needs Ethernet at scale. AI workloads cannot tolerate the delays in the network, because the job can only be completed after all flows are successfully delivered to the GPU clusters. All it takes is one culprit of worst-case link to throttle an entire AI workload. Three improvements are being pioneered by Arista and the founding members of the Ultra Ethernet Consortium to improve job completion time.
Number one, packet spraying. AI network topology needs packet spraying to allow every flow to simultaneously access all parts of the destination. Arista's developing multiple forms of load balancing dynamically with our customers. Two is flexible ordering. Key to an AI job completion is the rapid and reliable bulk transfer with flexible ordering using Ethernet links to optimally balance AI-intensive operations, unlike the rigid ordering of InfiniBand. Arista is working closely with its leading vendors to achieve this. Finally, network congestion. In AI networks, there's a common incast congestion problem whereby multiple uncoordinated senders can send traffic to the receivers simultaneously. Arista's platforms are purpose-built and designed to avoid these kind of hotspots, evenly spreading the load across multi-packs across our virtual output queuing, VoQ lossless fabric.
In terms of annual 2023 product lines, our core, which consists of cloud, AI and datacenter products, are built upon our highly differentiated Arista Extensible Operating software system stack. It is successfully deployed across 10, 25, 100, 200 and 400 gig speeds. Our cloud networking products deliver power-efficient, high availability zones without doubling the cost of redundancy as datacenters demand insatiable bandwidth capacity and network speeds for both the front-end and back-end storage and compute clusters. The core drove approximately 65% of our revenue. We continue to gain share in our highest performance switching of 100, 200 and 400 gig ports to obtain the number one position, at approximately 40-plus percent, according to industry analysts.
We have increased our 400-gig customer base from 600 customers in 2022 to approximately 800 customers in 2023. We expect both 400 and 800 gigabit Ethernet will emerge as important pilots for AI back-end GPU clusters. We are cautiously optimistic about achieving our AI revenue goal of at least $750 million in AI networking in 2025. Our second market is network adjacencies comprised of routing, replacing routers and our cognitive campus workspaces. We continue to make progress in campus aiming for the $750 million revenue by 2025 that we have shared at many Analyst Days. Our investments in cognitive wired and wireless, zero-touch provisioning and the introduction of AGNI, Arista Guardian for Network Identity as well as AVA sensors for threat mitigation is resonating well with our campus customers.
The post-pandemic campus is seeking network-as-a-service overlay and zero-trust network embedded in with high availability, observability and consistency across our OS and management domains. We are also successfully deployed in many routing edge and peering use cases. Just in 2023 alone, we introduced six EOS software releases across 600 new features and 50 platforms. In fall of 2023, we introduced our WAN routing system with a focus on scale, encryption and WAN transit routing capabilities. It has positioned us well, giving our customers a seamless enterprise LAN and WAN portfolio. The campus and routing adjacencies together contribute approximately 19% of revenue. Our third category is network software and services based on subscription models such as Arista A-Care, CloudVision, DANZ Monitoring Fabric or DMF observability and advanced threat sensors for network detection and response.
Arista's subscription-based network services and software contributed approximately 16% of the total revenue. We surpassed 2,400 cumulative customers with CloudVision, pivotal to building a modern operating model for the enterprise. Please note that perpetual software licenses are not included here and are counted inside the core or adjacent markets. While 2023's headline has been mostly about AI we are pleased with the momentum of enterprise and provider customers as well. Arista continues to diversify its business globally with multiple use cases and verticals. We have more than doubled our enterprise revenue in the last three years and we are becoming the gold standard for client to cloud to AI networking with one EOS and one CloudVision foundation.
Our million-dollar customer logos increased steadily in 2023 at approximately 35% as a direct result of our campus and enterprise momentum. Three principles continue to differentiate us as we are poised to be a market-share gainer in the enterprise. One, best-in-class, highly available proactive products with resilience and hitless upgrades at multiple levels. Two, zero-touch automation for predictive client-to-cloud one-click operations that relies less on human staff or manual operations and is instead software-driven. And finally, prescriptive insights based on AIML autonomous virtual assist AVA algorithms for increased security, observability and root cause analysis. Our foundational and network data lake architecture and the ability to gather, store and process multiple modalities of network data is the only way to reconcile all the incongruent silos for network operators.
While legacy vendors that are 30 to 40 years old are aiming for consolidation, Arista remains the only pure-play networking innovator earning top spots in Forrester Wave's programmable switching and customer validation in Gartner's voice of customer for campus in 2023. In December 2023, we conducted one of our largest customer events called Innovate in Vegas. Well, not my most favorite location, our customers and prospects founded very exciting and compelling for their network transformation initiatives. They resonate deeply with our Arista 2.0 vision, building best-of-breed, data-driven networking platforms. In summary, as we wrap up another fantastic year in 2023, I am so proud of the team's execution across multiple dimensions. They have all worked tirelessly to improve our operational metrics such as lead times, gross margin and on-time shipments.
Simply put, we outpaced the industry in quality, support and innovation. We set the direction for the future of networking, working intimately with our strategic customers. Despite limited visibility at this time, we reiterate our double-digit growth of 10% to 12% from Analyst Day, aiming for approximately $6.5 billion in 2024. With that, I'd like to turn it one last time to review our financial metrics with Ita Brennan. Ita?
Ita Brennan: Thanks, Jayshree and good afternoon. This analysis of our Q4 and full year 2023 results and our guidance for Q1 2024 is based on non-GAAP and excludes our 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 are provided in our earnings release. Total revenues in Q4 were $1.54 billion, up 20.8% year-over-year and towards the upper end of our guidance of $1.50 to $1.55 billion. Services and subscription software contributed approximately 17% of revenue in the fourth quarter, up from 16.8% in Q3. International revenues for the quarter came in at $343.5 million, or 22.3% of total revenue, up from 21.5% last quarter.
This quarter-over-quarter increase largely reflected a healthy contribution from our in-region EMEA customers. Overall gross margin in Q4 was 65.4%, well above our guidance of approximately 63%, and up from 63.1% last quarter. As a recap for the year, 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 additional inventory reserves as customers refined their forecast product mix. Operating expenses for the quarter were $262.7 million or 17.1% of revenue, up from last quarter at $255.6 million. R&D spending came in at $165 million or 10.7% of revenue, consistent with last quarter, reflecting lower level of new product introduction costs versus what we experienced in the first half of 2023 and what we expect for the first half of 2024.
This reflects the timing of prototype and other costs associated with the development of next-generation products. Sales and marketing expenses were $83.4 million or 5.4% of revenue, up from $79 million last quarter, with increases -- increased sales compensation and travel costs. Our G&A costs came in at $14.3 million or 0.9% of revenue, up from $12.1 million last quarter, reflecting some seasonal fourth-quarter spending. Our operating income for the quarter was $744 million or 48.3% of revenue. Other income and expense for the quarter was a favorable $54.5 million and our effective tax rate was 16.8%. This slower-than-normal quarterly tax rate reflected the release of tax reserves due to the expiration of the statute limitations and some true-up of jurisdictional earnings mix.
This resulted in net income for the quarter of $664.3 million or 43.1% of revenue. Our diluted share number was 318.85 million shares, resulting in a diluted earnings per share number for the quarter of $2.08, up 47.5% from the prior year. Now turning to the balance sheet. Cash, cash equivalents and investments ended the quarter at approximately $5 billion. We did not repurchase shares of our common stock in the quarter. To recap our repurchase program to date, we have 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 $144.5 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 for the fourth quarter. We generated approximately $526.5 million of cash from operations in the period, reflecting strong earnings performance combined with some increase in deferred revenue offset by reductions in taxes payable. DSOs came in at 61 days, up from 51 days in Q3, reflecting the timing of shipments and seasonal strength in service renewal billings. Inventory turns were 0.07 times, down slightly to 1.1 last quarter. Inventory increased slightly to $1.95 billion, reflecting the ongoing receipt and consumption of components from our purchase commitments and an increase in switch-related finished goods. Our purchase commitments at the end of the quarter were $1.59 billion, down from $2 billion at the end of Q3.
We expect to continue to reduce our overall purchase commitment number. However, we will maintain a healthy position related to key components, especially as we focus on new products. Our total deferred revenue balance was $1.51 billion, up from $1.195 billion in Q3. The majority of the deferred revenue balance is services related and directly linked to the timing and term of service contracts, which can vary on a quarter-by-quarter basis. Our product deferred revenue balance increased approximately $153 million over last quarter. This was ahead of our expectations for the quarter and yet again shows that this balance can move significantly on a quarterly basis. As of now, we expect this balance to decline somewhat in Q1 '24, but still be up significantly from Q3 '23 levels.
Accounts payable days were 72 days, up from 44 days in Q3 and second, the timing of inventory receipts and payments. Capital expenditures for the quarter were $6 million. I would now like to turn the call back to Jayshree. Jayshree?
Jayshree Ullal: Thank you, Ita, first of all, for an incredible eight and a half years as our Chief Financial Officer. We're going to miss you a lot and wish you all the best in your next innings. And if you ever miss an earnings call, please come, we'll invite you for one. Now, to describe our Q1 2024 guidance, it's my pleasure to introduce our incoming Chief Financial Officer, Chantelle Breithaupt for her very first earnings call at Arista. Welcome, Chantelle.
Chantelle Breithaupt: Thank you, Jayshree. Ita, congratulations on all that you've achieved during your tenure with Arista. Your partnership during our transition is greatly appreciated. Since joining Arista, I've been impressed by both the outstanding leadership team and the highly innovative engineering team who both serve a set of marquee customers that are redefining the future of networking. Arista began shipping products in 2008 and in 15 years, the annual bandwidth of the datacenters has grown 350 overall. In just the past two years, the annual bandwidth has doubled with Arista shipping a cumulative 75 million ports in that timeframe. Our acceleration of the data center switching market in recent quarters is evidenced by our market-share gains in the 20-plus percent range of both ports and dollars.
I am thrilled to be joining Arista in such an exciting time. Now turning to our outlook for the first quarter of 2024 and the remainder of the fiscal year. We remain confident with our Analyst Day view which calls for fiscal year 2024 revenue growth of 10% to 12%. This reflects our outlook for moderated cloud spending after multiple years of accelerated growth combined with a continued growth trajectory in the enterprise business. For gross margin, we reiterate the range for the fiscal year of 62% to 64%, with Q1 '24 expected to be at the lower end due to a heavier cloud mix including some expected release of deferred revenue. In terms of spending, we expect to invest in gross spending faster than revenue. In line with our Analyst Day view, with an operating margin of approximately 42% in 2024.
This incremental investment may include go-to-market resourcing and increased new product introduction costs to support our product roadmap. This latter trend is already evident in Q1 ‘24 as R&D is expected to rebound from the unusually low levels in the second-half of 2023. On the cash front we will continue to work to reduce our working capital investments and drive some further reduction in inventory as we move through the year. Our structural tax rate is expected to remain at 21.5%, back to the usual historical rate up from the unusually low one-type rate of 16.8% experienced last quarter Q4 FY '23. With all of this as a backdrop, our guidance for the first-quarter, which is based on our non-GAAP results and excludes any non-cash stock-based compensation impacts and other non-recurring items is as follows.
Revenues of approximately $1.52 billion to $1.56 billion, gross margin of approximately 62%, and operating margin at approximately 42%. Our effective tax rate is expected to be approximately 21.5% with approximately 319.5 million diluted shares. In summary, I am excited to lead Arista 2.0 journey as CFO. We will migrate our best of breed products to best of breed data-driven platforms, enabling our impressive TAM of $60 billion. With that, I now turn the call back to Liz for Q&A. Liz?
Liz Stine: Thank you, Chantelle. 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.
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