Arista Networks Inc (ANET) 2021 Q2 法說會逐字稿

Welcome to the Second Quarter 2021 Arista Networks Financial Results Earnings Conference Call.

(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.

I will now turn the call over to Mr. Charles Yager, Director of Product and Investor Advocacy.

Sir, you may begin.

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, 2021.

If you'd 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 2021 fiscal year, longer-term financial outlooks for 2021 and beyond, our total addressable market and strategy for addressing these market opportunities, the potential impact of COVID-19 on our business, product innovation 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, Charles.

Thank you, everyone, for joining us this afternoon for our second quarter 2021 earnings call.

I hope you're all being safe and vaccinated in these post pandemic times, especially with the resurgence of the Delta variant.

I would also like to take this opportunity to warmly welcome Liz Stine, our new Director of Investor Relations Advocacy, working closely with Charles.

Liz is a long-time Aristan with deep networking expertise and most recently ran our South Central region as the Systems Engineering Manager.

Welcome, Liz.

Back to Q2 2021 specifics.

We delivered revenues of $707.3 million for the quarter with a record non-GAAP earnings per share of $2.72.

A-Care services and software renewals contributed approximately 22% of revenue.

Our non-GAAP gross margin of 65.2% was influenced by enterprise momentum and software and services contribution.

We are pleased with the healthy customer traction, including new customer logos and record million-dollar customers in the mainstream enterprise.

In Q2 2021, while cloud titans were our largest vertical, the enterprise was a close second, followed by financials and specialty cloud providers tied at third place and service provider at fourth place.

International contribution was strong at 27% and with the Americas at 73% for the quarter.

We surpassed the cumulative of 50 million cloud networking port shipments this quarter, and we consider this to be a key golden milestone.

In light of the industry-wide supply chain shortages and escalating cost of components, rate and expedite logistics, I would like to invite John McCool, our Senior Vice President and Chief Platform Officer, to shed some more light on our manufacturing execution.

Welcome, John.

Thanks, Jayshree.

The continued industry-wide impact of COVID on global supply chain output, combined with increase in demand for electronics across all segments, is expected to remain for the foreseeable future.

Component lead times are the highest we've seen and have roughly doubled from pre-pandemic norms.

Most notable are semiconductor lead times, which have extended in the range of 40 to 60 weeks.

Factories are operating near full capacity, limiting flexibility for changes in demand.

Therefore, we expect extended lead times and escalating product costs due to expedites and elevated component increases in 2021 and 2022.

To mitigate these headwinds, we've taken a number of steps in Arista manufacturing.

First, we improve manufacturing procedures to maximize capacity and material utilization.

We are increasing our purchase commitments for 2022 forecast to adjust for increased component lead times.

We placed additional emphasis on inventory for our new products to offset supply constraints.

Finally, we are working closely with our strategic suppliers to plan for capacity expansion programs.

Clearly, we are redoubling our efforts and execution in this challenging macro environment and look forward to supply chain improvements in the second half of 2022 and beyond.

Back to you, Jayshree.

Thanks, John.

We really appreciate the diligence and disciplined work that you and the entire manufacturing team have stepped up to.

We welcome Susan Hays, your newest Vice President of Manufacturing, as a strong addition.

We also thank our customers for their patience and understanding during our lead time constraints and will strive to keep doing better as we recover in second half 2022.

Our enterprise customer momentum has never been stronger.

Continuing on our theme of enterprise wins, I would like to share with you 3 examples of strength and success.

The first win was in the retail sector for both data center and campus.

We began with the data center win with Arista's hallmark EOS for DANZ or data analysis switching and routing.

We expanded in 2021 with Cognitive Campus for both power over Ethernet wired switches and our wireless providing a natural expansion into these use cases.

Retail markets cannot tolerate downtimes with the magnitude of IoT proliferation they have.

Arista was able to perform real-time upgrades without downtimes across 100-plus stores and warehouses.

In the absence of retail remote staff in hand, we drove automation across all these stores with open APIs and CloudVision.

Our second win was a major U.S financials for both data center and routing.

Arista continues to expand its enterprise routing use cases, not just supporting with data center with Arista EOS features, but also a more software-led simplified automated deployment of core routing in the spine using standard phase routing protocols with VXLAN, EVPN, and Multicast.

Our customer was able to rapidly migrate from legacy to Arista within a few months, enabling billions of transactions.

An international media and entertainment campus win included a customer who wanted an extension of their data center in the campus with simple operating system, easy to scale, common spine deployment using CloudVision.

This customer took a build-as-you-go approach for flexibility and visibility.

This also included device access for back-to-work applications with our cognitive WiFi.

In all of these 3 examples, enterprise customers [were looking] for an alternative, and Arista was chosen as the disruptor with superior product capability and a cohesive client-to-cloud strategy to unify silo data sets consistently.

Arista's innovation, combined with high quality and support, is becoming the gold standard for customers to build cognitive cloud networking.

According to industry experts, Arista continues to gain switching market share across large enterprises and providers.

We are proud to be the #1 market leader in 100-gigabit Ethernet ports for the fifth consecutive year.

We see 2021 as the first year of inflection for higher speeds ranging from 100 to 200 to 400 gigabit after 18 months of trials.

We have now shipped more than 2.5 million ports of high-performance ports in the first half of 2021, according to analysts, placing us also at #1 leadership in the combined 100-gig, 200-gig and 400-gigabit Ethernet high-performance cloud switching.

In summary, Arista is well positioned for the next phase of our growth in cloud and data-driven networking.

We do this with proactive platforms, predictive operations and a prescriptive experience.

And we believe we are poised to achieve increasing market share with greater business diversification.

And while the path forward is paved with supply chain obstacles, volatile customer demand and your normal typical competitive tactics, I believe Arista, which means, "To be Great" in Greek, will live up to its name and with our A game, our A customers and our teams.

With this, I'll pass it over to Ita, our Chief Financial Officer, for financial specifics.

Thanks, Jayshree, and good afternoon.

This analysis of our Q2 results and our guidance for Q3 is based on non-GAAP and excludes our noncash stock-based compensation impacts, certain acquisition-related charges and other nonrecurring items.

A full reconciliation of our selected GAAP to non-GAAP results is provided in our earnings release.

Total revenues in Q2 were $707.3 million, up 30.8% year-over-year and well above the upper end of our guidance of $675 million to $695 million.

Shipments remained somewhat constrained in the period as we continue to carefully navigate industry-wide supply chain shortages and COVID-related disruptions.

Services and subscription software contributed approximately 22.3% of revenue in the second quarter, up from 21.4% in Q1.

International revenues for the quarter came in at $193.2 million or 27% of revenue, up from 25% in the first quarter.

This shift in geographical mix on a quarter-over-quarter basis reflected strong international deployments by our cloud titan and specialty cloud customers, combined with healthy performance from our in-region businesses.

Overall gross margin in Q2 was 65.2%, above the upper end of our guidance range of approximately 63% to 65%.

While we recognize some incremental supply chain costs in the period, these were more than offset by a healthy mix of enterprise and software revenues for the quarter.

Operating expenses for the quarter were $189.8 million or 26.8% of revenue, up from last quarter at $180.9 million.

R&D spending came in at $119.6 million or 16.9% of revenue, up from last quarter at $110 million.

This reflected increased employee-related costs and higher new product introduction spending in the period.

Sales and marketing expense was $67.9 million or 8.2% of revenue, down from $59.5 million last quarter with lower demo related expenses in the period.

As a reminder, we continue to benefit from lower COVID-related travel and marketing expenses.

Our G&A costs came in at $12.3 million or 1.7% of revenue, consistent with last quarter.

Our operating income for the quarter was $271.7 million or 38.4% of revenue.

Other income and expense for the quarter was a favorable $1.7 million.

And our effective tax rate was approximately 20.7%, reflecting an improved geographical mix.

Other income and expenses for the quarter included approximately $2 million of interest income, offset by some unfavorable FX amounts.

This resulted in net income for the quarter of $216.8 million or 30.6% of revenue.

Our diluted share number was 79.71 million shares, resulting in a diluted earnings per share number for the quarter of $2.72, up approximately 29% from the prior year.

Now turning to the balance sheet.

Cash, cash equivalents and investments ended the quarter at approximately $3.3 billion.

We did not repurchase shares of our common stock during the second quarter.

As a recap, we have now repurchased [$763 million] or 3.6 million shares against our Board authorization to repurchase $1 billion worth of shares over 3 years, commencing in Q2 '19.

We will continue to execute opportunistically against the remaining mandate.

Turning to operational cash performance for the second quarter.

We generated $263 million of cash from operations in the period, reflecting solid net income performance and continued investments of inventory and supply chain.

DSOs came in at 47 days, down from 51 days in Q1, reflecting the linearity of billings in the period.

Inventory turns were 1.7x, down slightly from last quarter at 1.8.

Inventory increased to $543.2 million in the quarter, up from $483.2 million in the prior period as we continue to buffer certain components of products.

Our total deferred revenue balance was $746 million, up from $720 million in Q1.

The majority of the deferred revenue balance is services related and is directly linked to the timing and term of service renewals, which can vary on a quarter-by-quarter basis.

Approximately $90 million of the balance, up from $70 million last quarter, represents product deferred revenue, largely related to acceptance clauses for new products across various customers and sectors.

As a reminder, we expect 2021 to be a year of significant new product introductions, combined with a healthy new customer acquisition rate and expanded use cases with existing customers.

These trends, in conjunction with reduced levels of upfront [in-process] testing, may result in increased customer-specific acceptance clauses and increased volatility in our product deferred revenue amount.

Accounts payable days were 53.7 days, up from 52.3 days in Q1, reflecting the timing of inventory receipt payments.

Capital expenditures for the quarter were $4.5 million.

Now turning to the outlook for the third quarter and beyond.

We reported strong year-over-year revenue growth of approximately 29% for the first half of 2021, reflecting healthy demand across all our market sectors, combined with favorable comparisons from the first half of 2020.

While we expect continued strength in demand as we move through the second half, we will likely see some deceleration in year-over-year revenue growth given the top line recovery experienced in the back half of 2020.

Turning to gross margin.

Industry supply constraints continue to pressure component costs.

Some of these incremental costs will initially be recorded as inventory and only be recognized in the income statement when the products are sold in future periods.

With this as context, we will continue to reiterate our gross margin outlook of 63% to 65%, with customer mix remaining the key driver of volatility on a quarter-by-quarter basis.

Turning to spending and investments.

We remain committed to growing our investments in R&D to support innovation across the business and sales and marketing to support our go-to-market expansion.

With regard to cash flow, we expect to fund approximately $40 million of CapEx in the third quarter for the purchase of land to build a data center and engineering location in Santa Clara.

We'll provide more details on this project over the coming quarters.

Finally, our outlook discussed above and our guidance for Q3 reflects our current understanding of COVID-19 and its impact to our business and supply chain.

This remains an inherently uncertain situation, and we will need to continue to monitor and attempt to mitigate new challenges as the situation unfolds.

With all of this as a backdrop, our guidance for the third quarter, which is based on non-GAAP results and excludes any noncash stock-based compensation impacts and other nonrecurring items, is as follows.

Revenues of approximately $725 million to $745 million; gross margin of 63% to 65%; operating margin of approximately 37%.

Our effective tax rate is expected to be approximately 21.5% with diluted shares of approximately 80 million shares.

I will now turn the call back to Charles.

Charles?

Thank you, Ita.

We are now going to move to the Q&A portion of the Arista earnings call.

(Operator Instructions) Thank you for your understanding.

Operator, take it away.

(Operator Instructions) Your first question comes from the line of Meta Marshall with Morgan Stanley.

Great.

I'm guessing, you'll get quite a few questions on this today.

But just if you could give a sense of if the supply chain constraints are -- worsen any portion of the portfolio?

And then maybe as it relates to that, where the inventory is.

I guess, just trying to get a sense of is it on kind of the high-speed products or more of the campus service provider portfolio.

Thanks, Meta.

I think just about every component is affected in our supply chain, I'll let John or Ita comment.

But we're affected on chips, memory, copper, passive components, freight, logistics, expedite fees.

I don't know if I can pinpoint.

So it affects all our products.

And the lead times vary, as you heard, they've all doubled.

So we've been experiencing anywhere from 20 weeks to 60 weeks or 40 weeks to 60 weeks like you said, John, right?

So depending on the past, we are experiencing component levels of increase across the board, campus, routing, switching, data center, you name it.

And they're at the component level.

Now we're going to try and absorb as much of it and offset as much of it as we can and not pass it on to our customers if we can help it, except in modest levels.

But I don't think it's anything more than across the board.

Your next question comes from the line of David Vogt with UBS.

A competitor just recently noted, as you guys are talking about that they're seeing some orders placed a little bit earlier, suggesting that there's been a little bit of a pull forward given sort of the industry constraints.

Can you guys just kind of explain a little bit how you're thinking about visibility relative to your order book and backlog, given the strength this quarter and sort of the supply constraints.

Does this lead to better visibility, obviously, over the next, let's call it, 2 to 3 months?

And what does that mean for the fourth quarter without getting into specific guidance.

Sure, David.

Well, as you know, we've always had limited visibility, but the last few quarters have noted that our visibility has gone up due to our lead times.

So I think there's a direct proportion to long lead times, long -- slightly longer visibility.

So particularly with the cloud titans that Anshul works closely with.

We have been able to get visibility beyond the 1 to 2 quarters that we normally get.

And we do have visibility into 2022.

And I think it's directly tied to them planning better and realizing that the longer lead times, they need to know what they're going to do in 2022 for us to supply product.

Anshul, you want to add some more to that?

Yes, I would say we're not seeing order pull-ins or if customers are doing it, they won't tell us.

It's much more the nonbinding demand signals we get is where the discussions happen with customers.

That's how we get our visibility from them.

It's just prudent planning, David, from a customer.

Your next question comes from Amit Daryanani with Evercore ISI.

I guess the question is really around the 400-gig opportunity.

And I think in the last couple of years, you've spent a lot of time explaining your folks how your software stack is really differentiated against white box risk.

I would love to get your perspective as the underlying technology gets more complicated, with 400 gig or 800 gig, what's the potential for cloud titans that have historically relied more on white box to start talking to Arista.

And I would love to know, if you're seeing a shift in customers that have skewed more white box and always build their own product now looking to perhaps buy.

Amit, the companies that build around white boxes are fairly sophisticated, so they're not short out on talent.

If they are committed to our mission, they will go ahead with it.

So I don't believe if any changes happen in the industry, it'll be is simply because the next gen is harder to build.

But it's much more about the collaboration we have with them and the co-development partnerships we have here -- And we've talked about it in the past, so nothing has changed on that front.

We are moving along on our vision in a few situations where customers consider from buying from the outside, and that will take a few years to actually materialize.

No big change here expected.

Amit, I think the way to think of this is, if you want commodity 100-gig without our software stack and you just want to buy basic vanilla stuff, we will continue.

But if we really appreciate our collaboration, our engineering, our innovation and our software stack, then that's when Arista gets chosen.

Your next question comes from the line of Aaron Rakers with Wells Fargo.

Congratulations on the quarter.

I wanted to actually ask about the progression of the subscription business within the model.

As we look at the services line, is there any way or how we investors should start to think about that as being an increasingly visible growth driver for the company?

Thanks, Aaron.

Thank you for the wishes.

We wish we could ship more.

I think the real issue to think of subscription is a long-term indicator of not necessarily just revenue, but the stickiness of our business, right?

When you look at CloudVision, cloud U.S,.

what we're doing with network detection and response with AI-driven security or (inaudible) big it acquisition with dense monitoring fabric.

These are all, if you will, layered icing on the cake.

And the icing contributes good margin and obviously has a long-term 1-year, 2-year or 3-year subscription.

So the revenue shows up a little bit later, but their bookings are very strong, as you can imagine, from that.

So we will continue to see strong software service renewals as well from our A-Care.

And so the 2 together, we believe we've always said will be a 20% to 25% contributor to the business.

Your next question comes from the line of Samik Chatterjee with JPMorgan.

Jayshree, you did comment starting off that you're seeing strong demand from enterprise customers.

Wondering if you can just talk about what you're seeing from the other customer verticals like is demand accelerating.

Similarly, for example, the cloud titans as well as some of the telcos.

And keeping that backdrop in mind does look like the third quarter guidance is more like a 4% increase when traditionally, we've seen like a high single digit.

So should I just infer that all supply kind of driven in terms of the moderation relative to historical trends?

Well, first of all, thank you, historically -- historical beside, I think all our 5 verticals are doing well.

In that, I would highlight cloud titans and enterprise as stronger.

But that doesn't take away from the contribution and success we're having with specialty cloud, financials or the service providers.

I guess it's a case of rising tides raise everything.

So all of them are contributing well.

Relative to our Q3, demand is strong.

I wish we could ship more.

But I wouldn't compare it necessarily to our last Q3 in the post pandemic area.

I would just say on the basis of large numbers, we're doing well.

Yes.

I think if you look at last year, I mean, given the year that it was, we saw a very significant uptick in Q3.

It was up 12% or something quarter-over-quarter.

That was just more of an assemblance of what was happening with COVID at a time.

Right.

And previous years weren't like that.

I think the Q3 guidance 21% at the midpoint year-over-year, that's a good place to start, right.

Your next question comes from the line of Fahad Najam with MKM Partners.

In terms of the pricing environment, can you comment on -- are you planning on charging on any of the incremental costs that you're experiencing.

Can you also talk about the dynamics you're seeing in the market in terms of pricing or your competitors increasing their pricing as well, or are they using it as an opportunity to kind of absorb the cost and maybe kind of aggressively price.

So maybe a comment there.

We appreciate it.

Fahad, I'm not in a position to talk about competitors.

Maybe they'll share that with you.

They certainly don't with us.

But I will say that we're going to try our best to absorb the cost.

On selective models, we will have to -- where the increases are significant, increase prices slightly.

But we don't expect the impact on that, on our backlog, our existing inventory.

So the real impact of any changes we make will impact our gross margin or our price changes next year.

Your next question comes from the line of Jeff Kvaal with Wolfe Research.

Yes.

I am wondering you started to talk a little bit about deceleration in the back half of the year, which makes complete sense.

I'm wondering if there are any the onetime tailwinds that you are expecting this year that we should be considering when we start to think about the shape of 2022.

Obviously, you all don't want to talk too much about it, but anything that we should be considering as we have to think about it?

Yes.

I mean I think it's a little early to start getting too specific about 2022.

This year did have an unusual sell-through just because of the pandemic and how 2020 played out, right?

We're putting up some very good numbers now this year, that's obviously setting a good base for us to grow up next year.

So I bear that in mind.

But the business is solid.

It's strong demand, I think we're executing well, and it's broader, right?

It's across the verticals.

So we'll probably take a shot at giving you some [book-ins] and next quarter for 2022, but it's just a little too early yet.

Thanks, Jeff.

A nice job, Anshul, Chris and the whole team for creating demand.

Sure.

Thanks, Jayshree.

Your next question comes from the line of Paul Silverstein with Cowen.

Clarification question.

Jayshree, did that here you -- and you did say that you're expecting 20% growth now for top line for the year?

No.

You did not hear her say that.

Jayshree would never say those things, Paul.

But Ita, what did you think?

About the midpoint of the guidance for Q3 year-over-year growth.

Let me ask the question, last quarter, I think you responded -- in response to a question, you said for this year, you're definitely expecting 15% growth for the year in the Q&A.

Any thoughts for what you're expecting now for the year?

And can you also comment on how much the supply chain is costing you in revenue and in margin structure?

Yes.

I mean I think for the year now, when you layer in Q3 and you think about Q4, you can probably get to a reasonable view for the year, right?

I don't know that we want to put a specific number, but you can get there, right?

Once we give you the Q3 number, it becomes a lot easier.

In terms of how much -- clearly, lead times are very extended, right?

It's always hard to kind of compare that to some kind of normal world.

We could obviously do more revenue if lead times weren't that extended.

How much it's really hard to put a number, and I don't think we're going to try to put a number on that.

All right.

Given that response, can I ask you within cloud titan since historically, you've been highly concentrated in Microsoft and Facebook, but of more recent vintage, you could be having some more success with some of the other folks, like them Google in particular.

Any insight you could share with us?

I think, Paul, you summarized it very well.

Anshul and the team are doing a great job in both diversification across all our sectors.

And while Microsoft and Facebook are very strategic, very important customers, we have other cloud titan customers also.

Next question please.

Your next question comes from the line of Sami Badri with Credit Suisse.

A little -- just a clarification on just Ita's comments there regarding the second half deceleration now.

Ita, I was hoping you could give us some sequential guidance.

Is there any potential that sequential growth could be negative in 3Q and 4Q?

And if I just extrapolate out and I forecast a little bit out from where we are today and even though the above, we're getting into the low 20% range.

I just want to clarify that there would be any sequential decline in 2021.

Yes.

So I mean we've given you Q3, right, at the midpoint, and there's clearly growth there quarter-over-quarter.

Again, we're not trying to guide Q4, but Q4 is usually a good, strong quarter.

So I'll leave you to draw your own conclusions from that, but I think we've pretty much laid it out for the year.

Sami, I think the message we'd really like to convey is demand is strong.

We're doing well.

We need to execute on our shipments.

And we can only approach this -- our shipments 1 quarter at a time because our supply chain is so constrained.

Your next question comes from the line of Rod Hall with Goldman Sachs.

I guess I wanted to ask you about the gross margin guidance.

When we were talking to Cisco on a similar note, they had said that the supplies impact on their gross margins was bottoming or on their margins was bottoming in their guide.

And I'm curious whether this guide for September, from your point of view is kind of at the bottom?

In other words, gross margins at least go sideways from there?

Or do you think it's sort of an unknown at this point and things can could continue to worsen.

So that's my first question, and then I have a follow-up.

Yes.

I think, Rod, on the supply chain stuff, I mean, we did have some significant supply chain impact even in Q2, right?

It just was more than offset by the customer mix, right?

So I think as we look forward, I mean we are paying more for certain components, et cetera, than normal, and that cost will get recognized whenever we ship those components and the products that are in those components are incorporated into.

So we will see some drag on gross margin probably for some time, just given the inventory and purchase commitment levels that we have.

We are -- the mix is healthier, the enterprise mix is helping to offset that.

But customer mix is still by far the biggest driver.

So if we have a quarter where it's a heavy cloud mix, you are going to see pressure on that gross margin number for the quarter.

But I think over time, we feel like we can stay in that 63% to 65% range.

I think that would go safe kind of place to be.

But I guess what I'm thinking is you're already kind of signaling some pressure in 64% in the next quarter because that's down over 1% from this quarter.

And I'm wondering, do you -- so when you say that, do you think it's probable that you have materially lower margin than 64%?

Or do you think when you say drag, do you mean 64% just is a possibility for longer?

Yes.

No, again, I think the biggest driver will be the customer mix.

So in a quarter where the heavy customer mix, yes, you could be back at 64%, you could even be below that, right?

But again, it will be because of a particular mix of a particular quarter, right?

So I think the range is still very valid.

The 65% plus that we saw this quarter is a really good, solid enterprise mix that's helping to offset some stuff.

So you will see -- I mean, gross margin is going to move around a bit over time, but I think we're still very comfortable in that range.

As Ita said, Rod, a lot of our inventory costs will be realized later in this year and next year.

So the gross margin will actually be more pressured when those higher costs are realized.

And so then, if we have a really good enterprise mix, we could be on the better side of 63% to 65%.

If we have a high cloud mix, then I don't rule out the possibility of being on the lower side of 63% to 65%, right?

Recognizing that the costs have really going to enter it.

Nobody is predicting the semiconductor supply cost of shortages are going away in 2022.

No, definitely not.

And then that leads me to the enterprise trajectory, like enterprise spending indicators are very strong here as we look into the second half.

Just curious what your thoughts on the enterprise pipeline are?

I mean, does that look equally strong in your pipeline?

Or how does that look to you?

Yes.

Rod, I think you've run out of questions, but the short answer is yes.

Next question comes from the line of Jason Ader with William Blair.

My question is for Jayshree.

How do you see supply chain situation compare to prior periods in your career where you've seen supply constraints?

Well, I'm glad you're asking the oldest person here, close to the owners.

In my career of several decades, I've never seen a it be this bad, never.

This is the worst I've seen it.

And there's been some pretty big ups and downs.

So -- and more than the worst I've ever seen it, I think it's also going to be prolonged.

I guess we were all hopeful we would all recover from the COVID pandemic, but everything from copper shortages to wafer starts, assembly to manpower, people, logistics, freight, just about every aspect of it is challenged too.

So Anshul, do you want to add anything more to that as a younger person, yes?

Well, as you said, things are very, very constrained.

But I think what's happened is the world supply chain never planned for this bigger mismatch in supply and demand.

And as a result, when you run into a crunch, people try to book ahead and plan to rebuild buffers and so on.

But this is not an industry where you can react in 1 quarter.

This will last a long time the semiconductor industry is projecting maybe recovery in 2023, but who knows what our global demand will be at that time.

So we are in it and prepared for a longer run here.

And is it inevitable that at some point, we're going to see like a demand air pocket, Jayshree, just because everyone will have orders that they needed ahead of time, and we'll hit some type of air pocket?

I don't know the answer to that, Jason.

But I think given the business diversification we have, the planning of 1 type of customer will not affect the planning of others.

So I'm hoping that some of them are planning for 2022 and some are planning for ahead in 2023.

And so the air pockets will balance off, if you will.

Yes.

And the visibility, Jason, I think, to what the demand is for and when it will get deployed, at least with the larger customers is pretty good.

So that helps, right?

It's not they're not -- you're deploying over time, still, right?

That's right.

It's very much, as Ita said a land-and-expand situation.

You don't just land and then buy nothing for a long time.

Your next question comes from the line of Jim Suva with Citigroup Investments.

And I only have one question, and that's related to your strength in revenues that you've just seen and kind of the outlook, that strength?

Is it being driven across all your end markets?

Or are there kind of 1 or 2 that you really want to call out to us as if you were to look back, say, 6 or 9 months ago, you would not have guessed it would have been so strong because you really have posted really impressive results and a great outlook.

Thank you, Jim.

And again, a lot of credit goes to Anshul and his team.

So actually, I would love for you to answer this question, but let me just preface it by saying all 5 verticals are very strong.

They're all growing double digits.

And in fact, I feel bad rating any of them as second or third or fourth or fifth place.

But if you ask me what I'm most positively surprised by, you might remember a year ago, Jim, we were less bullish on the cloud titans.

We thought they would even be flat to down.

So Anshul, do you want to add to that?

Sure.

Well, what a difference a year makes, [like you have] despite the COVID impact.

But the cloud titans are on a strong upgrade cycles at 400 gig and planning their transitions.

And not just 400, but a mix of 100 to 200, 400.

And the customers themselves are surprised that the end demand is so strong for their businesses.

So that's been a good upside for us.

And same is for enterprise.

We've talked about enterprise for quite some time.

But we're quite happy with the adoption by our customers, both in our prime areas in the market are also expanding into campus into monitoring into security.

And we have a long way to go.

It's a very large TAM, and we're just getting started there.

So that keeps us very positive on growth in that area too.

Congratulations.

Your next question comes from the line of Simon Leopold with Raymond James.

At the beginning of July, the U.S. government announced the cancellation of the JEDI project with a plan to put it out for rebid.

I'm just wondering how you would factor that into your own forecasting?

And modeling given that you sell into one of the essentially participants in that project.

Does this change your thoughts on this year and longer term?

What do you do in terms of a project when it comes to forecasting your overall business?

Thanks, Simon.

I don't think we really factored it in very much except making sure we had all the certifications.

You want to add to that, Anshul?

Simon, this is a contract over 10 years.

So it's not as if we saw any significant change in the last year related to that.

In addition, the contract the JEDI program might take on, but there's so many other programs the government is doing with various cloud companies.

So it just gets mixed into the noise.

We don't really see.

We never saw a big upside, I don't think there's any big downside either.

How big is government typically for you?

No.

But then this case, this wasn't going through us, right?

This was going through 1 of our cloud customers, which is why we don't see a direct impact...

It's not really government.

It's cloud titan.

Yes.

No.

I guess in general because government sounds like a good vertical, I don't know that you've talked about it in the past.

I know we haven't.

We could do a lot better.

Government is not big for us, but it's mixed into our enterprise momentum it has improved year-over-year.

But in terms of any kind of contribution, a large concentration, we have a long ways to go.

Nice question.

Your next question comes from the line of Tal Liani with Bank of America.

I'm trying to ask a question without asking it directly.

So the trick is looking for a big win with 1 of the cloud titans.

And the question I have is, what's your outlook for cloud titan?

Are there big kind of wins or big announcements in the pipelines that you're looking for?

Is there anything you can share with us about the puts and takes?

What could happen with cloud titans over the next few quarters?

Sure.

Tal, I thought you say you're very happy with the results so far, and there's no more upside expected.

Look, we're doing well with our customers.

Execution has been good.

You know it is a competitive market.

And despite that, we continue to do very well with both our hardware design, our supplier products and especially our EOS software.

There's no big change.

I mentioned this last year as well.

We are maintaining status quo in terms of customers.

If the customers grow, we grow with them.

We obviously don't control that aspect and can't forecast on their behalf.

But otherwise, it's more of moving on the next-gen architecture with these entities.

And while you think of them as cloud titan, internally, we think of each one as a market, right, that's that big and there's so much complexity.

But there's no big announcement we're making or about to make or help.

There's so many key milestones that need to be achieved before that can be done on anything that's dramatic or a big shift.

Can you -- if I can squeeze in another one, if not, it's okay.

Can you talk about the contribution of cloud titans to this quarter and also last quarter results.

I'm trying to understand how important is it, in relative terms, how important is it to the overall growth?

It's -- so we decided to go annually rather than quarterly, Tal, but it's staying within the annual targets we gave.

I believe we said it was 34% to 39%.

We bracketed it.

So that's the contribution from cloud titan, 34% to 39%.

What about the growth?

How much of the growth is it?

Is it proportionately much higher than the 35% to 39% of the growth?

No.

We don't comment on it.

It's really hard to look at it on a quarter-by-quarter basis.

The cloud and cloud contribution to growth is always going to be important.

-- enterprise is becoming more important, right?

But I don't think we want to try and do it on a quarter by quarter.

Yes, I think it will make more sense annually, Tal, because we're so constrained by shipments.

So it would be a false signal, if we said it was high, low or medium.

So I think on an annual basis, it's a much better number.

And the growth will be good.

It will definitely be double digits.

Still the #1 vertical.

And no, it's important for sure, anybody who thinks that it's not an important part of the mix.

Thank you, Tal.

I think we're ready for the next question.

Your next question comes from the line of John Marchetti with Stifel.

I was wondering if you could just spend a minute or 2 just talking about what you're seeing specifically in that 400 gig market.

Now obviously, we go back to the early part of the year, and it seems like we were pumping the brakes a little bit on expectations.

That seemed to change a little bit last quarter, you seemed a little bit more bullish there.

Just curious if you could spend a little bit of time, and I'm assuming that is still primarily cloud titan market, but just anything you're seeing there would be helpful.

Well, it's actually more than cloud titans.

I think Arista has been trialing 200 and 400 gigs in 2019, if I remember, when Andy was here and we talked about the whole portfolio of products.

So this combination of 10 -- not 10 -- 100, 200, 400, we expect to see a significant increase.

So just to give you some context here, we had about 75 customers last year, and we expect that to triple to quadruple this year in customers.

So it's way more than the cloud titans.

And your next question comes from the line of Ben Bollin with Cleveland Research Company.

Jayshree, you talked a little bit about getting some additional visibility from hyperscale partners versus history even into next year.

With that perspective, could you talk about how you see the evolution of 200 and 400 as they roll that out, how that develops and maybe how you think it compares with what you saw with 100 in terms of, I don't know, pace or speed of adoption?

Yes.

No, that's a really good question.

I think that 100 gig pace and adoption was remarkably fast.

It was probably over an 18-month period Anshul, correct me if I'm wrong, around 2016 to '18, something like that, right?

The 200, 400 gig has been more gradual.

And in very many use cases, it's coupled with 100 gig.

So that's what's so hard for us to separate out.

And we, I think, are finally at this inflection point or pivot point where we expect to see more 200-gig and 400-gig shipments in our cloud titan customer base in the second half of this year.

And I think this will continue and will be vibrant for at least the years to come, maybe longer.

Do you want to -- is there a long tail to that Anshul, you want to answer?

Ben, I think it's important to note that when the world went to 100 gig in 2016, 2017, 100 gig was very much compatible that was compatible with 40 gigs.

It cost the same as 40 gig and it was the same power consumption at 40 gig.

So that's a no-brainer to upgrade.

No-brainer, yes.

Upgrade.

200 and 400 gig are not the same.

The companies are going there are the ones absolutely need it.

And there were other technologies involved like the ZR optics needed for data center interconnection (inaudible) which were constrained last year and earlier this year as well.

So which is why this adoption curve is very different, and it's not at every layer of the network.

And I would not model that on the 2016, 2017 cycle.

These are different upgrade, cycles which is why you have to come back to what Jayshree was saying the combined 100, 200, 400.

They're winning around a lot in 100 gigs using new next-gen products as well, and that is very much material and matters.

One addition I'd like to make on the noncloud titan side, Ben, I know you're more focused on that, is many times they make sure they buy a product that's 200, 400 or even 800 gig capable, but they'll deploy only 100 gig, right?

So what's clearly happening now is customers are getting ready for the higher speeds independent on how they deploy them in timing.

Next question comes from the line of Jon Lopez with Vertical Group.

Ita, I believe you said in calendar Q1, you grew -- [cloud deferred] by about $40 million or so sequentially.

And I thought I heard you say it's another $20 million or so this quarter.

I guess -- the 2 questions I had there.

One, do you ascribe any of that to component constraints?

Or is that all product feature sets?

And then secondly, do you expect that to flow into the income statement in the second half of this year?

Or is that stuff you'll carry with you into 2022?

Yes.

So it's not really related to the supply side stuff.

It's more about new customers and new use cases, new products, right?

That's what drives that number.

I mean it is kind of even in Q2, if you look at it, some of that stuff was recognized and then we added other new stuff.

So there is kind of some churn underneath of that balance, right?

But I don't expect us to take any revenue -- net revenue, if you like, out of that bucket in Q3.

We'll see what happens in Q4, that's a bit further out.

But I think given the comments in the script around how that balance builds, I think we've got lots of new stuff happening.

So I think it's probably unlikely that we will be depleting that balance this year.

Your next question comes from the line of Alexander Henderson with Needham.

I was hoping you could talk a little bit about the environment in terms of pricing we've heard from some players in the market that Cisco is talking about 5% to 10% price increases on a variety of products, including switching and routing related products and passing through more price increases than what you alluded to.

You obviously suggested that you are going to be relatively careful with that and not push through a lot of pricing on your customers.

So is there a delta developing there?

And within that context, could you talk a little bit about the strategic approach of Cisco trying to bundle together the Arista -- excuse me, the Acacia products and whether that architectural change to a switch-routed optical platform is something that you concur with or which you think is a fool's errand.

Well, that was a loaded question.

So I'm going to break it into 2. Anshul, think about the Acacia one while I discuss the delta and pricing.

It's difficult for us to parse our competitors pricing.

But I can tell you, philosophically, we got backlog, we've got products in flight and we've got customers who are making their budget plan.

So we're going to try as much as we can in the short term to absorb the cost.

That said, we will have some slight price increases probably in the range of 5% on selective models that will affect our customer base in the tail end of this year and next year.

And it will still affect our gross margins if the mix changes dramatically to cloud titans as Ita has alluded to.

So all this to say, Alex, we're going to be very thoughtful because it's pain for us, and we're going to try and mitigate the pain for customers and only apply it where there's a real shortage and a real significant cost increase.

And Anshul, you want to take the Acacia question.

Alex, the way our customers buy ZR optics, and as you know, we've been involving these architectures since the 2016, 2017 timeframe for 100 gig, 100-kilometer optics.

The cloud companies especially learned this in the '90s and early 2000s.

They do not like bundled solutions.

They like to disaggregate, they disaggregate every layer, not just by boxes.

And the optics and the switches are not allowed to be built in a bundled manner.

They will run in separate RFP for each one.

[Here we come] -- we have to be independently competitive by these players to win, which is why this is not a concern.

And as we mentioned, optics have large spans and other companies can participate.

We don't have to -- we have our work cut out.

And we try to qualify as many optics vendors.

So at any given time, you have a team on so that's qualifying a number of vendors, right?

If there's a ZR optic tower out there, we've qualified it.

Yes.

At no risk.

There's a lead time on your qualification too, I understand.

(inaudible).

Your next question comes from the line of James Fish with Piper Sandler.

And Jayshree, I was going to comment before that age is just a sign of wisdom.

So I wouldn't say old, but just wise.

And with that being said let's (inaudible)...

Thank you, James.

I'll just let you and Anshul have that debate who's wisest though offline.

[She'll win that one.]

Good one.

And so you guys are starting to see some 5G core spending or at least the industry has picked up and we even saw AT&T and Microsoft kind of announce something on that decor.

Carrier grew pretty nicely.

It looks like if you use the midpoint of those ranges you gave.

Does your relationship with Microsoft help extend your reach in the Carrier environment as they look to take some of their core to the cloud?

Or will it be more of a fulfillment via support for Azure is the way to think about it?

Yes.

No, I think in the short term, it's very much a relationship tied to Azure.

But there's nothing that precludes particularly with their investments in 5G and some of the recent acquisitions we made.

As you know, service providers are a long-term test of our patience.

But when you win them, you win them well.

So we are seeing our own personal wins, independent on Microsoft, very much tied to upgrades to 5G, where we are the back -- the core routing and platform and spine.

But specific to Microsoft, I think it will take time.

It will probably emerge in the next several years.

Today, it's primarily Azure.

Okay.

We have time for one more question.

Last but not least.

This question comes from the line of Kyle McNealy with Jefferies.

This is Kyle on for George Notter.

Curious if there's any change in the mix of customers or ports using cloud EOS versus the traditional standard EOS, bundled with a hardware sale.

Maybe still quite small, but any quantifiable color you can provide around what the mix might currently be?

And could that help your gross margin at all or may be a little less sensitive to the supply chain issues that you're seeing in some areas?

Thanks, Kyle.

No cloud EOS is an example of a very strategic software platform, but it's very, very tiny in ports.

And it has more to do with our multi-cloud hybrid network strategy, where almost every one of these enterprise customers also has some premise strategies.

So I would say the strong influence of millions of ports are still on the mainstream platforms.

And cloud EOS is on top of that to connect into multicloud.

This concludes the Arista Q2 2021 earnings call.

We have posted a presentation which provides additional information on our fiscal results, which you can access on the Investors section of our website.

Thank you for joining us today.

Thank you for joining, ladies and gentlemen.

This concludes today's call.

You may now disconnect.