ARISTA-NETWORKS Earningcall Transcript Of Q2 of 2024

Jayshree V. Ullal -- Chief Executive Officer and Chairperson

Thank you, Liz, and thank you, everyone, for joining us this afternoon for our second quarter 2024

earnings call. As a pure-play networking innovator with greater than $70 billion TAM ahead of us, we

are pleased with our superior execution this quarter. We delivered revenues of $1.69 billion for the

quarter,  with  a  non-GAAP  earnings  per  share  of  $2.10.  Services  and  software  support  renewals

contributed strongly at approximately 17.6% of revenue.

Our  non-GAAP  gross  margin  of  65.4%  was  influenced  by  outstanding  manufacturing  discipline

realizing  cost  reductions.  International  contribution  for  the  quarter  registered  at  19%,  with  the

Americas strong at 81%. As we celebrated our 10th anniversary at the New York Stock Exchange

with our near and dear investors and customers, we are now supporting over 10,000 customers with

a cumulative of 100 million ports deployed worldwide. In June 2024, we launched Arista's Etherlink

AI platforms that are ultra-Ethernet consortium compatible, validating the migration from InfiniBand

to Ethernet.

This is a rich portfolio of 800-gig products, not just a point product, but in fact, a complete portfolio

that is both NIC and GPU agnostic. The AI portfolio consists of the 7060X6 AI switch that supports

64 800-gig or 128 400-gig Ethernet ports with a capacity of 51 terabits per second. The 7800 R4-AI

Spine is our fourth generation of Arista's flagship 7800, offering 100% nonblocking throughput with a

proven  virtual  output  queuing  architecture.  The  7800  R4  supports  up  to  460  terabits  in  a  single

chassis, corresponding to 576 800-gigabit Ethernet ports or 1,152 400-gigabit port density.

The  7700  R4-AI  distributed  Etherlink  switch  is  a  unique  product  offering  with  a  massively  parallel

distributed scheduling and congestion-free traffic spraying fabric. The 7700 represents the first in a

new  series  of  ultra-scalable  intelligent  distributed  systems  that  can  deliver  the  highest  consistent

throughput for very large AI clusters. Let's just say once again, Arista is making Ethernet great. First,

we began this journey with low latency in 2009 time frame.

And then there was cloud and routing in the 2015 era, followed by WAN and Campus in the 2020

era, and now AI in our fifth generation in 2025 era. Our Etherlink portfolio is in the midst of trials and

can  support  up  to  100,000  XTUs  in  a  two-tier  design  built  on  our  proven  and  differentiated

extensible  OS.  We  are  quite  pleased  with  our  progress  across  cloud,  AI,  campus,  and  enterprise

customers.  I  would  like  to  invite  Ashwin  Kohli,  our  newly  appointed  Chief  Customer  Officer,  to

describe our diverse set of customer wins in 2024.

Ashwin, over to you. 

Ashwin Kohli -- Senior Vice President-Customer Engineering

Many thanks, Jayshree. Thank you for inviting me to my first earnings call. Let me walk everybody

through the four global customer wins. The first example is an AI enterprise win with a large Tier 2

cloud provider, which has been heavily investing in GPUs to increase their revenue and penetrate

new markets.

Their senior leadership wanted to be less reliant on traditional core services and work with Arista on

new,  reliable,  and  scalable  Ethernet  fabrics.  Their  environment  consisted  of  new  NVIDIA  A100s.

However, it was being connected to their legacy networking vendor, which resulted in them having

significant  performance  and  scale  issues  with  their  AI  applications.  The  goal  of  our  customer

engagement was to refresh the front-end network to alleviate these issues.

Our  technical  partnership  resulted  in  deploying  a  two-step  migration  path  to  alleviate  the  current

issues using 400-gig 7080s, eventually migrating them to an 800-gig AI Ethernet link in the future.

The  second  next  win  highlights  our  adjacencies  in  both  campus  and  routing.  This  customer  is  a

large  data  center  customer,  which  has  deployed  us  for  almost  a  decade.  The  team  was  able  to

leverage  that  success  to  help  them  demonstrate  our  value  for  their  global  campus  network,  which

spans across hundreds and thousands of square feet globally.

The  customer  had  considerable  dissatisfaction  with  their  current  vendor,  which  led  them  to  a

last-minute  request  to  create  a  design  for  their  new  corporate  headquarters.  Given  only  three

months'  window,  Arista  leveraged  the  existing  data  center  design  and  adapted  this  to  the  campus

topology with a digital twin of the design in minimal time. CloudVision was used for visibility and life

cycle management. The same customer once again was struggling with extreme complexity in their

routing environment, as well with multiple parallel backbones and numerous technical complexities.

Arista simplified their routing network by removing legacy routers, increasing bandwidth and moving

to  a  simple  fixed  form  factor  platform  router.  The  core  spine  leverages  the  same  U.S.  software,

streamlining  their  certification  procedures  and  instilling  confidence  in  the  stability  of  the  products.

Once again, CloudVision came to the rescue.

The third example is the next win in the international arena of a large automotive manufacturer that

due to its size and scale, previously had more than three different vendors in the data center, which

created  a  very  high  level  of  complexity  both  from  a  technical  and  also  from  an  operational

perspective.  The  customer's  key  priority  was  to  achieve  a  higher  level  of  consistency  across  their

infrastructure, which is now being delivered via a single EOS binary image and CloudVision solution

from  Arista.  Their  next  top  priority  was  to  use  automation,  consistent  end-to-end  provisioning  and

visibility,  which  can  be  delivered  by  our  CloudVision  platform.  This  simplification  has  led  the

customer  to  adopt  Arista  beyond  the  data  center  and  extend  the  Arista  solution  into  the  routing

component of the infrastructure, which included our 7500 R3 spine platforms.

This  once  again  shows  a  very  clear  example  of  the  same  Arista  One  EOS  and  One  CloudVision

solution  delivering  multiple  use  cases.  And  Jayshree,  this  last  win  demonstrates  our  strength  in

service provider routing space. We have been at the forefront of providing innovative solutions for

service  provider  customers  for  many  years.  As  we  all  know,  we  are  in  the  midst  of  an  optical  and

packet integration.

As a result, our routers support industry-leading dense 400-gig ZR Plus coherent pluggable optics.

In this service provider customer example, we provided a full turnkey solution, including our popular

7280 R3 routers and our newly announced AWE 7250 WAN router as a BGP route reflector along

with CloudVision and professional services. We showcased our strength in supporting a wide variety

of  these  pluggable  coherent  optics,  along  with  our  SRX  and  EVPN  solutions,  which  allowed  this

middle  mine  service  provider  customer  to  build  out  a  400-gig  statewide  backbone  at  cloud-scale

economics. Thanks, Jayshree, and back over to you. 

Jayshree V. Ullal -- Chief Executive Officer and Chairperson

Well, thank you, Ashwin, and congratulations. Hot off the press is our new and highest Net Promoter

Score of 87, which translates to 95%. Hats off to your team for achieving that. It's so exciting to see

the momentum of our enterprise sector.

As a matter of fact, as we speak, we are powering the broadcasters of the Olympics, symbolic of our

commitment to the media and entertainment vertical. And so, it's fair to say that so far in 2024, it's

proving to be better than we expected because of our position in the marketplace and because of

our  best-of-breed  platform  for  mission-critical  networking.  I  am  reminded  of  the  1980s  when  San

was famous for declaring the network is the computer. Well, 40 years later, we're seeing the same

cycle  come  true  again  with  the  collective  nature  of  AI  training  models  mandating  a  lossless  highly

available network to seamlessly connect every AI accelerator in the cluster to one another for peak

job completion times.

Our  AI  networks  also  connect  trained  models  to  end  users  and  other  multi-tenant  systems  in  the

front-end data center, such as storage, enabling the AI system to become more than the sum of its

parts. We believe data centers are evolving to holistic AI centers, where the network is the epicenter

of AI management for acceleration of applications, compute, storage, and the wide area network. AI

centers need a foundational data architecture to deal with the multimodal AI datasets that run on our

differentiated EOS network data link systems. Arista showcased a technology demonstration of our

EOS-based AI agent that can be on the NIC itself or alternatively, inside the host.

By  connecting  to  adjacent  Arista  switches  to  continuously  keep  up  with  the  current  state,  send

telemetry  or  receive  configuration  updates,  we  have  demonstrated  the  network  working  holistically

with  network  interface  cards  such  as  NVIDIA  BlueField,  and  we  expect  to  add  more  NICs  in  the

future.  Well,  I  think  the  Arista  purpose  and  vision  is  clearly  driving  our  customer  traction.  Our

networking platforms are becoming the epicenter of all digital transactions, be they campus center,

data center, WAN centers, or AI centers. And with that, I'd like to turn it over to Chantelle, our chief

financial officer, to review the financial specifics and tell us more.

Over to you, Chantelle. 

Chantelle Breithaupt -- Chief Financial Officer

Thanks,  Jayshree.  It  really  was  great  to  see  everyone  at  the  New  York  Stock  Exchange  IPO

celebration event. Now turning to the numbers. This analysis of our Q2 results and our guidance for

Q3  is  based  on  non-GAAP  and  excludes  all  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 $1.69 billion, up 15.9% year over year, significantly above the upper end

of  our  guidance  of  $1.62  billion  to  $1.65  billion.  Growth  was  delivered  across  all  three  sectors  of

cloud, enterprise, and provider. Services and subscription software contributed approximately 17.6%

of revenue in the quarter, up from 16.9% in Q1.

International revenues for the quarter came in at $316 million or 18.7% of total revenue, down from

20.1%  in  the  prior  quarter.  This  quarter-over-quarter  decrease  was  driven  by  a  relatively  weaker

performance in our APJ region. The overall gross margin in Q2 was 65.4%, above our guidance of

64%,  up  from  64.2%  last  quarter  and  up  from  61.3%  in  the  prior-year  quarter.  The  year-over-year

gross margin improvement was primarily driven by a reduction in inventory-related reserves.

Operating expenses for the quarter were $319.8 million or 18.9% of revenue, up from last quarter at

$265 million. R&D spending came in at $216.7 million or 12.8% of revenue, up from $164.6 million in

the  last  quarter.  This  primarily  reflected  increased  headcount  and  higher  new  product  introduction

costs in the period. Sales and marketing expense was $85.1 million or 5% of revenue compared to

$83.7 million last quarter, with a double-digit percentage increase of headcount in the quarter versus

the prior year.

Our G&A costs came in at $18 million or 1.1% of revenue, up from last quarter at $16.7 million. Our

operating  income  for  the  quarter  was  $785.6  million  or  46.5%  of  revenue.  Other  income  and

expense  for  the  quarter  was  a  favorable  $70.9  million,  and  our  effective  tax  rate  was  21.5%.  This

resulted in net income for the quarter of $672.6 million or 39.8% of revenue.

Our diluted share number was 319.9 million shares, resulting in a diluted earnings per share number

for  the  quarter  of  $2.10,  up  32.9%  from  the  prior  year.  Turning  to  the  balance  sheet.  Cash,  cash

equivalents, and investments ended the quarter at $6.3 billion. In the quarter, we repurchased $172

million of our common stock at an average price of $282.20 per share.

Of  the  $172  million,  $82  million  was  repurchased  under  our  prior  $1  billion  authorization,  which  is

now complete, and the remaining $90 million was purchased under the new program of $1.2 billion

approved  in  May  2024.  The  actual  timing  and  amount  of  future  repurchases  will  depend  upon

market  and  business  conditions,  stock  price,  and  other  factors.  Now  turning  to  operating  cash

performance  for  the  second  quarter.  We  generated  $989  million  of  cash  from  operations  in  the

period, reflecting strong earnings performance with a favorable contribution from working capital.

DSOs came in at 66 days, up from 62 days in Q1, impacted by large service renewals at the end of

the  quarter.  Inventory  turns  were  1.1x,  up  from  one  turn  last  quarter.  Inventory  decreased  to  $1.9

billion  in  the  quarter,  down  from  $2  billion  in  second  half  prior  period,  reflecting  a  reduction  in  our

raw materials inventory. Our purchase commitments and inventory at the end of the quarter totaled

$4 billion, up from $3.5 billion at the end of Q1.

We expect this number to stabilize as supplier lead times improve, but we'll continue to have some

variability  in  future  quarters  as  a  reflection  of  demand  for  our  new  product  introductions.  Our  total

deferred revenue balance was $2.1 billion, up from $1.7 billion in Q1. 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 

increased

approximately $253 million versus last quarter.

As  a  reminder,  we  expect  2024  to  be  a  year  of  new  product  introductions,  new  customers,  and

expanded  use  cases.  These  trends  may  result  in  increased  customer  trials  and  contracts  with

customer-specific  acceptance  clauses  and  increase  the  variability  and  magnitude  of  our  product

deferred revenue balances. Accounts payable days was 46 days, up from 36 days in Q1, reflecting

the timing of inventory receipts and payments. Capital expenditures for the quarter were $3.2 million.

As we enter the second half of fiscal year 2024, we are encouraged by the momentum that we see

in the market. Our existing innovative product portfolio, along with our new product introductions, are

well  suited  for  our  cloud,  AI  enterprise,  and  providers  customers.  We  will  continue  to  invest  in  our

R&D and go-to-market through both people and processes. With all of this as a backdrop for fiscal

year '24, our revenue growth guidance is now at least 14%.

Gross margin outlook remains at 62% to 64%, and operating margin is now raised to approximately

44%.  Our  guidance  for  the  third  quarter  based  on  non-GAAP  results  and  excluding  any  noncash

stock-based  compensation  impacts  and  other  nonrecurring  items  is  as  follows:  revenues  of

approximately  $1.72  billion  to  $1.75  billion,  gross  margin  of  approximately  63%  to  64%,  and

operating  margin  at  approximately  44%.  Our  effective  tax  rate  is  expected  to  be  approximately

21.5%, with diluted shares of approximately 321 million shares. With that, I now turn the call back to

Liz.

Liz? 

Liz Stine -- Director, Investor Relations

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. 

Operator

Questions & Answers: