Why Shares of Arista Networks Dropped Today

What happened

Shares of Arista Networks (NYSE: ANET) slumped on Friday after the networking hardware company reported its first-quarter results. While Arista beat analyst estimates for both revenue and earnings, guidance calling for a slowdown in revenue growth and gross margin deterioration seems to have overshadowed an otherwise positive report. As of 11:25 a.m. EDT, Arista stock was down about 9.2%.

So what

Arista reported first-quarter revenue of $472.5 million, up 40.8% year over year and about $9 million higher than the average analyst estimate. Product revenue soared 39.9% to $407.6 million, while service revenue jumped 47.1% to $64.9 million.

A slumping chart laid over columns of numbers

Image source: Getty Images.

Non-GAAP earnings per share came in at $1.66, up from $0.93 in the prior-year period and $0.15 better than analysts were expecting. Revenue growth and a 20-basis-point improvement in GAAP gross margin compared to the first quarter of 2017 drove earnings higher.

In the second quarter, Arista expects revenue between $500 million and $514 million, representing year-over-year growth of 25.2% at the midpoint. The company also sees its non-GAAP gross margin coming in between 62% and 64%, down from 64.4% during the first quarter.

Now what

Arista's first-quarter results were solid, handily beating expectations, but its outlook wasn't quite as good. Management attributed the weak gross margin guidance to an anticipated mix shift toward cloud revenue in the second quarter, and it said the revenue growth slowdown will be due to a tough comparison to 2017.

These are minor issues in the grand scheme of things, but the stock's sky-high valuation may be acting as a multiplier. Prior to Friday's plunge, shares of Arista traded for 13 times last year's sales and 50 times last year's GAAP earnings. Those ratios bake in lofty expectations that Arista's guidance likely didn't meet.

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Timothy Green has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Arista Networks. The Motley Fool has a disclosure policy.