Arista Networks (ANET)

Q4 Results

We wrote a long price on Arista Networks on 1st September 2023 which we believe is a good introduction to the company and it can be found here.  We also wrote a belated review of its Q3 Results at the end of last year which can be seen here.

The current note is a review of the Q4 and full year end results which were released on 12^th February 2024.   

Q4 2023 and full year 2023 Results 

Arista reported the following for the full year 2023.

• Revenue of $5,860mn, an increase of 33.8% compared to fiscal year 2022.

• GAAP gross margin of 61.9%, compared to GAAP gross margin of 61.1% in fiscal year 2022.

• GAAP net income of $2,087mn, or $6.58 per diluted share, compared to GAAP net income of $1,352mn or $4.27 per diluted share, in fiscal year 2022.

For four quarter ending 31 December 2023 the numbers were as follows

• Revenue of $1,540mn, an increase of 20.8% from the fourth quarter of 2022.

• GAAP gross margin of 64.9%, compared to GAAP gross margin of 62.4% in the third quarter of 2023 and 60.3% in the fourth quarter of 2022.

• GAAP net income of $614mnn, or $1.92 per diluted share, compared to GAAP net income of $427mn, or $1.35 per diluted share, in the fourth quarter of 2022.

Financial Forecast for Q1 2024 

For the first quarter of 2024, they expect:

• Revenue between $1.52bn to $1.56 bn;

• Non-GAAP gross margin of approximately 62%; and

• Non-GAAP operating margin of approximately 42%.

Balance sheet 

Cash and cash equivalents at the end of 2023 were $ 1.9bn compared with $ 671mn at the end of 2022.

Cash, Cash equivalents and investments ended the quarter at approximately $ 5bn.

Net current assets are $ 8.4bn, 84% of total assets of $ 9.95bn. 

Non-equity long term liabilities were just $ 131mn.

Cash flow Statement.

Cash from operating activities in 2023 was $ 2.0bn compared with $ 492mn in 2022.

Quarterly number in Details 

Q4 revenues at 1.54bn were 20.8% higher (y/y) and at the top end of the range of expectations.

Product revenues grew 20.3% while services grew faster at 29.2% (y/y).  Services now account for 15% of total revenues.

Q4 Operating Profit was $ 744mn, 58.7% higher than in the same quarter in the previous year.  Q4 Net Profit was 55.5% higher than in the same period in the previous year.

The tax rate was 16.8% lower than the normal 21.5%. This was from a one-off situation, and they expect it to go back to 21.5% in the current quarter. If we adjust for this, the growth in Net Profit was lower but still an impressive ~ 50%.

GAAP EPS was $2.08 and was 54.1% higher than in the same period in the previous year.

The fact that revenue growth of 20.8% led to net profit growth of ~50% shows the strong operating leverage still inherent in the business model.     

 Quarterly Revenue growth is slowing but was still a respectable 20.7% (y/y). 

Margins across the board are higher both on a q/q basis and the y/y basis.

Earnings Conference Call highlights:

Big Picture View

“Arista began shipping products in 2008.  And in 15 years, the annual bandwidth of the datacentres has grown 350-fold.  In just the past two years, the annual bandwidth has doubled with Arista shipping a cumulative 7mn ports in that time frame”.

On the full year 2023 numbers: 

“We gave initial guidance of 25% year on year revenue growth and instead achieved well beyond that at 33.8%, driving revenue to $ 5.86 bn coupled with a record eps for the year of $6.94, up 50%.”

On International Revenue

“International contributions for the quarter registered at 22.3% ... this was one of our strongest performing international quarters in recent history.”  This “…largely reflected a healthy contribution from our in-region EMEA customers.”

On Breakdown of Demand

“Cloud Titan were 43% and Enterprises (segment) was strong at 36%.  Meta and Microsoft accounted for 21% and 18%.” 

Like the earnings call of other tech companies, AI was a prominent topic. In working on AI networks, Arista is committed to Ethernet based solutions and approaches. The main rival approach is InfiniBand which is owned by Mellanox Inc.  The latter was acquired by Nvidia and now is the networking division is a division of Nvidia.

“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 the flows are successfully delivered to the GPU Clusters.”

“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.”

“We are cautiously optimistic about achieving our AI revenue goal of at least $ 750mn in AI networking in 2025.”

“We expect both 400 and 800 gigabit ethernet will emerge as AI back-end GPU clusters.” 

The Core Product

“..our Core, which consists of Cloud, AI and datacentre products are built on the highly differentiated Arista EOS system stack”.

“The Core drives 65% of our revenues.  We continue to gain share in our highest performing 100, 200 and 400 gig ports.”

Beyond the core they have “routing, replacing router and our Cognitive Campus workspaces” The latter is for Enterprise. 

Innovation

 “In 2003 alone, we introduced 6 EOS software releases across 600 new features and 50 platforms.”

Subscription Revenue

“Arista’s subscription-based network services and software contributed approximately 16% of the total revenue.”

These includes CloudVision which we discussed in detail in our initial September 2023 note. 

“We surpassed 2400 cumulative customers with CloudVision, pivotal to building a modern operating model for the enterprise “

Arista is no longer just a cloud networking company as they have made significant progress with enterprise customers. 

“We have more than doubled our enterprise revenues in the last three years and we are becoming the gold standard for client-to -client to AI networking with an EOS and CloudVision foundation”. 

Outlook

“despite limited visibility at this time, we reiterate our double-digit growth of 10% to 12%,  …aiming for $ 6.5bn in 2024. 

Conclusions 

This was a very good set of results. 

Revenue growth is slowing a little compared with the high recent growth but 20% + is still an impressive performance.   Margins continue to improve despite the huge increase in the scale of the business.

Meta Platforms and Microsoft are important source of customer concentration, but they are investing heavily in infrastructure and are “good horses to be riding.”    

Arista continues to innovate and have gained traction among enterprises since they started focusing on them in the last three years. 

The company’s asset light model (all manufacturing is outsourced) continues to deliver.

The company has a strong and very liquid balance sheet (negative net debt of $ 5bn and current assets are ~80% of total assets) and continues to generate strong free cash flow.   

The stock fell after the results due to the headline revenue forecast for Q1 2014 of 10% to 12% growth. 

The company has a history of conservative guidance.  They have a new CFO who does not want to start their career with revenue miss in Q1 2024. 

Let us look at the numbers in detail.

In Q1 2023, the company recorded revenues of $ 1.35bn.

For Q1 2024, they are forecasting revenue between $ 1.52bn to $ 1.56 bn. This implies a y/y growth of 12.5% to 15%.  

As we noted above, the y/y growth has been falling but in Q$ 2023 the growth was still 20.8%. This forecast seems conservative. 

 The company emphasised they are seeing in growth in enterprise demand which is growing faster than cloud. The company also expressed confidence about the revenue they will get in AI. 

“Our AI performance continues to track well for the 750mn revenue goal we set last November at Analyst Day.” 

During the earnings conference call, the company was challenged by analysts about what was described as the “aggressive conservatism” of their forecast. 

This was their response:

“This reflects our outlook moderated cloud spending after multiple years of accelerated growth, combined with a continued growth trajectory in the enterprise business.”

This is not convincing.  Microsoft, Amazon and Google have all said in their most recent earnings’ conference calls that demand for cloud services has picked up in Q4 2024 after a few quarters of slower growth. 

Arista do not appear to have updated their forecasts. 

AI investment is likely to be huge boost for Arista although that is more likely to be a story for H2 2024 and 2025. 

We believe Arista’s revenue guidance will prove to be conservative.  Time will tell.

Valuation 

Arista’s share price has risen 100% in the last year, and it has been a strong performer in our portfolio.  Some significant profit taking should not be a surprise and indeed should be welcomed. 

Arista’s shares currently trade at a forward P/E Ratio and a forward EV/EBITDA ratio of about 38 times.

This is quite high and suggests the stock is no longer cheap.   However, given the company likely to grow revenues at 18% plus for the next few years with both operating margins and ROE both likely to be 35%+, it does not seem expensive,

This is a very good company with a strong record of effective innovation and implementation.  It also has a fortress balance sheet. 

We will continue to hold on.  We hope there will some significant profit taking which will allow us to add to our holding at lower levels perhaps at a price of $ 220. 

We do not expect to be so lucky.