Arista Networks, Inc.

Welcome to the first quarter 2023 Arista Network's 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. If at any time during the conference you need to reach an operator, please press the star followed by zero. 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 Stein, Arista's Director of Investor Relations, you may begin.

Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me on today's call are Jay Sriyulal, Arista Network's President and Chief Executive Officer, and Ida Brennan, Arista's Chief Financial Officer. This afternoon, Arista Network issued a press release announcing the results for its fiscal first quarter ending March 31st, 2023. If you would like a copy of the release, you can access it online at our website. During the course of this conference call, ERISA Networks Management will make forward-looking statements, including those relating to our financial outlook for the second quarter of the 2023 fiscal year, longer-term financial outlook for 2023 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 time, product innovation, working capital optimization, and the benefits of acquisitions, which are subject to the risks and uncertainties that we discussed in detail in our documents filed with the SEC. specifically in our most recent Form 10Q and Form 10K, 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 Jay Shree.

Thank you, Liz, and happy Monday, everyone, and a happy month of May. We delivered revenues of $1.35 billion for the quarter with a non-GAAP earnings per share of $1.43. Services and software support renewals contributed approximately 13.5% of the revenue. Our non-GAAP gross margins of 60.3% was influenced by supply chain overheads and cloud tightening concentration. We expect our gross margins to improve every quarter throughout this year. International contribution registered at 17.5%, with the Americas strong at 82.5% for the quarter. While we will shift to reporting our vertical segments on an annual basis, I would like to share some overall trends we've seen. We do expect Cloud Titans will moderate compared to our 2022 triple-digit growth, while Enterprise is likely to be more steady-state. It is evident that our lead times are improving. Our visibility to customer forecasts, therefore, are now beyond six months, or now below six months, I should say, and they are shrinking. Despite macro uncertainty, we endorse consensus of 26% annual growth to approximately 5.5 billion revenue in 2023. On the product side, we made many exciting Q1 announcements. At OFC 2023, we introduced our vision for linear drive optics for intra and inter data center connectivity at 800 gig and beyond. This was a highlight for both Arista and the optical industry at large, delivering the promise of low power and improved price performance for demanding AI workloads. Speaking of AI, the mandate to avoid idle states in expensive and large AI processor clusters requires that specialized AI network. Key characteristics include wire rate and lossless delivery of large and synchronized bursts of data at 400 to 800 gig speeds. Today, the combination of RDMA Nix, RDMA stands for remote direct memory access, and Rocky, which is RDMA over converged Ethernet, along with the switches, allows Ethernet to become that predictable transport network. Ethernet, of course, brings familiarity, great economics, massive install base, standards with industry-wide interoperability, and many merchant silicon options. This is supporting compute and data intensive workloads based on generative AI inference and large language model training applications. Arista's CloudCast customers are resonating with our AI and switching strategy for platforms. Presently, we are in the midst of trials leading to production deployments this year in 2023. We expect AI networking to become meaningful throughout the years and through the decade ahead. In Q1 2023, Arista also formalized our new entry into the wide area network with our WAN routing system. Our enterprise class routing platform is based on carrier and cloud neutral transit with cloud vision pathfinder service. Not surprisingly, we support Arista's EOS operating system stack, delivering that operational model for network as a service and wide area as a service. We are targeting mission critical enterprises where high volume and encrypted traffic matter in a modern WAN. Arista has partnered with Equinix to develop and deploy the WAN routing system, and WAN routing will be included as part of our network adjacency category. In the non-cloud category, we have registered a solid number of million dollar customers, which is a direct result of our momentum in the enterprise and campus throughout the past year. Let me illustrate with a few customer wins. The first use case is an international government win. The customer's objective was to detect illegal activities such as money laundering, terrorism, scams, and other criminal behavior in real time by collecting and analyzing data. Arista's data-driven AI clusters optimizes network assurance for mission-critical AI and ML workloads. Using advanced features like microburst and fan-in congestion management, ultra-deep packet buffer memory with latency analyzer provides real-time telemetry, visibility, automation, and dynamic controls for their AI and ML data centers, all based on open standards Ethernet. Our second win continues on the international theme and highlights our ever-growing strength in the education vertical, where Arista's proposal for edge campus platforms ranging from power over ethernet switches, wireless access points, and automation was a decision factor. We leveraged Cloud Vision Q cognitive unified edge, coupled with Arista validated design as an automation framework across multiple distributed locations, bringing unmatched flow visibility. The next win is in the US financial sector. This customer had grown organically and inorganically through acquisitions and was looking to modernize their entire infrastructure, moving their data closer to the cloud to enable a hybrid cloud architecture. This design included multiple greenfield data centers hosted in Equinix, requiring active-active 400 gigabit Ethernet spines, securely encrypted data center interconnects, and internet connectivity at each site. For a smooth upgrade in their campus environment without disruption to their end users, Arista's SSU, or Smart Systems Upgrade feature, played a prominent role. We also helped them build a digital twin of their environment, modeling their designs for automation. The next customer highlights healthcare as a critical win for network monitoring and security analysis tools at their remote data center facilities. This holistic view of port mirroring sessions for traffic analysis from all their remote data centers was a superior approach. Arista's centralized DMS, Dan's Monitoring Fabric, was better than disparate and expensive tools at each remote location. Our final customer win was looking for real-time in-house video streaming and editing capabilities. Video would be stored on their storage arrays, which could be connected at 100 gigabit Ethernet. and then accessed and rendered by the clients, be they PCs or Macs, with 25 gigabit Ethernet. Arista's core strength in the media vertical comes from its deep buffer virtual output queuing architecture with our R3 platforms. The simplicity, scalability, and flexibility shows this elegant design and highlights our strengths in the media and entertainment vertical. So as you can see, this is a recurring theme in all our customer wins, where Arista is deploying innovative solutions based on a consistent architecture, allowing each and every customer to modernize their network with the power of our platform. And with that, I'd like to hand to Ida, our CFO for Financial Metrics.

Thanks, Jayshree, and good afternoon. This analysis of our Q1 results and our guidance for Q2-23 is based on non-GAAP, excludes all 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 is provided in our earnings release. Total revenues in Q1 were $1.351 billion, up 54% year-over-year, and well above the upper end of our guidance of $1.275 to $1.325 billion. We continue to experience improvements in component supply in the quarter, supporting more consistent levels of manufacturing output and some improvements in lead times. Services and subscription software contributed approximately 13.5% of revenue to the first quarter, down from 15.8% in Q4. This largely reflected accelerated growth in product revenues, while services and software continued to grow on a more consistent basis. International revenues per quarter committed $236 million, or 17.5% of total revenue, down from 23.5% last quarter. This quarter-over-quarter reduction largely reflected an unusually high contribution from our EMEA and region customers in the fourth quarter. Overall, we continue to see outsized growth in the U.S., largely due to ongoing domestic strength from our Cloud Titan customers. Overall growth margin in Q1 was 60.3%, in line with our guidance of approximately 60%. We continue to recognize incremental supply chain costs in the period, combined with a healthy cloud mix. Operating expenses for the quarter were $257.5 million, or 19.1% of revenue, up from last quarter at $235.3 million. R&D spending came in at $164.8 million, or 12.2% of revenue, up from $153.2 million last quarter. This primarily reflected increased headcount and new product introduction costs in the period. Sales and marketing expense was $75.9 million, or 5.6% of revenue, compared to $67.4 million last quarter, with increased headcount costs and higher variable compensation expenses. Our G&A top came in at $16.8 million, or 1.2% of revenue, consistent with last quarter. Our operating income for the quarter was $556.8 million, or 41.2% of revenue. Other income and expense for the quarter was a favorable $17.7 million, and our effective tax rate was 21.2%. This resulted in net income for the quarter of $452.5 million, a 33.5% of revenue. Our diluted share number was 315.6 million shares, resulting in a diluted earnings per share number for the quarter of $1.43, up 70% from the prior year. Now turning to the balance sheet, cash, cash equivalents, and investments ended the quarter at approximately $3.33 billion. In the quarter, we repurchased $82.3 million of our common stock at an average price of $111.9 per share. We've now repurchased $825.5 million, our 7.8 million shares, at an average price of $106 per share under our current billion-dollar board authorization. This leaves $174.5 million available to 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 flow for the first quarter. We generated approximately $375 million of cash from operations in the period, protecting strong earnings performance, partially offset by ongoing investments in working capital. DSOs came in at 57 days, down from 67 days in Q4, protecting a strong collections quarter with good linearity of billing. Inventory turns were 1.3 times down from 1.6 last quarter. Inventory increased to 1.7 billion in the quarter, up from 1.3 billion in the prior period, reflecting the receipt of components from our purchase commitments and a slight increase in switch-related finished goods. Our purchase commitments at the end of the quarter were 2.9 billion, down from 3.7 billion at the end of Q4. We expect this number to continue to decline in future quarters as component lead times improve and we work to optimize our supply positions. Our total deferred revenue balance was $1.092 billion, up from $1.04 billion in Q4. The majority of the deferred revenue balance is services-related and directly linked to the timing and term of service contracts, which can vary at a quarter-by-quarter basis. Our product deferred revenue balance was flat to last quarter. Accounts payable days were 55 days, up from 43 days in Q4, protecting the timing of inventory receipts and payments. Capital expenditures for the quarter were $5.6 million. Now turning to our outlook for the second quarter and beyond. As we move through 2023, we expect to resolve the final kinks in the supply chain, allowing for more consistent manufacturing output and improving lead times to our customers. We do, however, expect these reduced lead times to also result in reduced visibility, with customers no longer needing to make purchase decisions so far in advance of deployment. In addition, we expect some moderation in customer spending, especially with our cloud-tightened customers following a year of accelerated demand in 2022. All of that being said, we believe customer engagements and current deployments across the business support the current consensus revenue growth rate for 2023 of approximately 26%. In terms of quarterly trends, you should expect moderating year-over-year growth as the year progresses with more difficult prior year comps. On the gross margin front, beginning in Q2, we expect to see some steady improvement as we consume fewer broker parts and have the opportunity to optimize manufacturing output while maintaining a healthy contribution from our cloud customers. Now turning to spending and investment, we continue to monitor the overall macro environment carefully and will prioritize our investments as we move through the year. This will include a focus on targeted hires in R&D and go-to-market as the team sees the opportunity to acquire talent. On the cash front, I will continue to focus on supply chain and working capital optimization. You should expect some continued growth in inventory on a quarter-by-quarter basis as we receive components from our purchase commitment. With all of this in the backdrop, our guidance for the second quarter, which is based on non-GAAP results and excludes any non-cash stock-based compensation impacts and other non-recurring items, is as follows. Revenues of approximately 1.35 to 1.4 billion Growth margin is approximately 61%, operating margin at approximately 40%. Our effective tax rate is expected to be approximately 21.5%, which eludes shares of approximately 317 million shares. I will now turn the call back to Lynn.

Thank you, Ida. We will now move to the Q&A portion of the ERISA 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.

We will now begin the Q&A portion of the Arista earnings call. In order to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, again, press the star 1. We ask that you pick up your handset before asking questions in order to ensure optimal sound quality. Your first question comes from the line of Erin Rakers with Wells Fargo. Your line is now open.

Yeah, thanks for taking the question. I'm just curious, kind of the commentary around the hyperscale cloud as component lead times shrink, how would you characterize, if at all, the visibility in that vertical and specifically how maybe that's evolved or changed relative to, let's say, the commentary or the thoughts a quarter ago? Thank you.

Yeah. Hey, Aaron. I'll kick it off and maybe Anshul can help me. As you know, historic visibility with the Cloud Titans, if you take out, if you subtract the last two years, which were largely supply chain related, was typically two quarters, right? And for a period of time last year and the year before, we were starting to get four quarters of visibility. As our lead times are improving, our visibility is also shrinking, especially with that segment, because they can make decisions closer to our lead times. So I would say our visibility has reduced from last year to this year by two quarters, and it's roughly six months.

Thank you, Erin. We can go ahead and take the next question.

Your next question comes from the line of Anton Scherbein with New Street Research. Your line is open.

Hi. Thank you very much for taking my question. So at the CMZ, I think you provided an AI-intensive network, Sam. of two three billions in the next few years and during last earnings broadcom said that their ethernet switch chips deployed in ai was well over 200 million in 22 and they forecast that this could grow to well over 800 million in 23. so i imagine that that would correspond to four or five billion in revenues um this is therefore already well above the time that you estimated Am I missing anything, or did the time expand considerably more than you were anticipating at the CMD?

Sure. As you know, there's a lot of talk about AI, and it's a very exciting topic in many ways. First, you have to separate out numbers that broadcast to you versus where our customers will deploy systems. There's an offset of when they ship chips versus when they can ship systems and often by quarters sometimes it could be as long as a year right given the lead times and so on that are going on in the market second i think ai is still in its infancy i don't think we know really how big it will be it's clearly on a very good trajectory it will keep on growing and it is a great opportunity for us for sure um and we're doing very well with some of our top customers as jesse's talked about in the primary script as well

Yeah, and just to add to what Anshul said, our forecast of 2 to 3 billion is more in the 2025 arena. Market analysts are already showing larger numbers than that, 2035 to 2027 arena. I think market analysts are already projecting it's double that, and certainly Broadcom is enthusiastically looking at their chip deployments. But again, as Anshul alluded, By the time Broadcom has a chip, the chip gets built into a system by us, and then the system gets deployed by our cloud customers. It can be one to two years.

Thank you. Your next question comes from the line of Sameek Jatterjee with JPMorgan. Your line is open.

Hi. Thanks for taking my question. If you don't mind, can we just dive in, dig a bit deeper into the inventory number? I think getting a few questions on that. Obviously, materials step up in the inventory in the quarter, particularly, as you mentioned, lead times for your products are now six months. Do we sort of conclude that your lead times will take a step function down if you have this much inventory at this point? And if your visibility into demand is starting to come in a bit, why sort of maybe help me think about why the inventory continues to sort of move up higher from here rather than sort of start to come down in line with the visibility into demand? Thank you.

This is Edith. You know, when you think about the purchase commitments that we have and that we made some time ago, right, we're going to have to continue to work through those, you know, as we go through the rest of this year, particularly on some key components. There were long lead times. We had to place commitments, you know, for kind of this year. Well, you know, earlier last year in order to secure that supply. So those components will continue to come into inventory and obviously they'll go out of inventory as well as we, build products, et cetera. So, you know, we have a healthy deployment pipeline in front of us on the system side, but we are still going to gather components based on when those purchase commitments were made and the timing of those purchase commitments. So, you know, if you look at the total of inventory plus purchase commitments, it came down in excess of $400 million this quarter. So we'll continue to kind of work that down over time, but you will see the shift from purchase commitments into inventory parts, and then obviously we'll sell that inventory.

And, Simi, just to add to that, we're not managing the business as just-in-time inventory. As Ida said, we have 72-week lead time still on many of our components, even with the supply chain improvements. So we have to plan ahead, and if we want to get products to our customers in 6 to 12 months, assume a position on the inventory, and especially do so on common components where we feel confident that there is demand, and we will continue to fulfill that demand this year and next year.

Thank you. Thanks for taking the question.

Thanks, Renee. Your next question comes from the line of David Vogt with UBS. Your line is open.

Great. Thank you, guys, for taking my question. I just want to follow up basically on the question on AI inventories and sort of revenue growth expectations for the second half. So if I'm hearing you correctly, it sounds like you think given tough comps and sort of spending patterns from the Titan Group is going to come down bring revenue growth down to about 15% in the second half on a year-over-year basis. And yet, you know, as you just mentioned, inventories still need to come down. So how do we square that with sort of the optimism in the marketplace that looks like you took your TAM up from about $40 billion to about $50 billion for data center and campus in the deck? I'm just trying to square the deceleration that you're talking about versus sort of the expanded TAM that you're also kind of highlighting in the deck. Thanks.

Hey, David. I think, first of all, the TAM we took up was for 2027, not Q3, Q4, 2023, just to be clear. And I think we continue to feel very optimistic about our long-term demand in enterprise, cloud, and AI. So we shouldn't confuse the comps and difficulty of comparing Q3 2022 with Q3 2023 with our long-term demand and TAM. Both are valid statements. But as you know, the cloud is a volatile market, and the titans will spend a lot one year and then spend a little less the other year as they're digesting it and deploying it. So if you look across multiple years, they're going to have the strong demand and do well.

Yeah, and David, this is very consistent with what we talked about last quarter, right? I mean, because of the comms and the pattern in the comms, we're going to grow quarter by quarter, growing each quarter consecutively. But you will see that deceleration just because of how last year's kind of revenue trended as well, right? So I don't think there's anything new here. In fact, we probably took up the overall number a little bit to get to the 26%.

Right. We said 25 in November. Now we're saying 26.

Right. Thank you. Thanks, guys.

Thank you. Your next question comes from the line of Misha Marshall with Morgan Stanley. Your line is open.

Great, thanks. Maybe just zeroing in kind of on the Cloud Titans vertical, you know, you mentioned kind of reduced visibility, but just wanted to clarify, you know, had you seen any changes in orders or any push-outs kind of within the quarter of orders and within kind of your near-term guidance of, orders that you thought were going to take place that are maybe getting pushed out.

Thanks. I'll let Anshul answer the question, but I would say it's sort of a give and a take. Some things are getting pushed out and some are getting pulled in. The silver lining is clearly AI. That's not getting pushed out, but some of the deployments of cloud regions are getting pushed out. Anshul, you want to answer that?

If I can add some more color to key areas that we've been tracking. I know we only want to talk about AI. Remember, this DCI market and backbone, which is what started the 400-gig cycle in the first place, those deployments are progressing as expected as well. So that part is steady state, and obviously AI is growing compared to what we knew before.

Great.

Thank you.

Your next question comes from the line of Sebastian Nagy with William Blair. Your line is now open.

Hi, thanks for taking the question. Just given this discussion around generative AI, maybe can you frame for us the advantages of Ethernet for building out these AI network fabrics and any metrics you might have that highlight these advantages versus something like InfiniBand?

Sure. I think I said this before, but I think the number one advantage of Ethernet is the fact that you're building a standards-based, multi-vendor, highly interoperable network where everything from troubleshooting to familiarity when you're connecting to the GPU clusters is very well known. So from a best-of-breed horizontal approach, Ethernet can win every time, and Ethernet technologies generally struggle. Having said that, the vertical approach that InfiniBand adopted for high-performance computing can be applied to GPU clusters as well. So I think it all depends on the customer's clusters and how large they are. And the larger they become, the more it favors Ethernet.

Great. Thank you.

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

Hi, guys. Thanks very much. I want to ask about non-cloud titans, the other part. Last year, it grew about 14.5%, and it was supposed to grow, by your guidance, kind of supposed to grow much faster this year. What happened this quarter? And again, if you don't provide exact numbers, even qualitatively, what happens this quarter with non-cloud Titan? How is demand shaping up when it comes to orders? I'm trying to neutralize the supply chain issue. Thanks.

Yeah. No, good question. Enterprise demand is pretty strong and steady. In fact, I would go as far as saying the customer activity has been just as strong as last year. And some of these macro things we hear about, you know, we are experiencing less of it, perhaps because we're a small fish in a big ocean, right? So, that said, obviously, our revenue has a high component of cell tightening concentration in Q1. So, the demand doesn't translate into direct revenue contribution in a specific quarter. But I think you will see a number far greater than the 15% through the year.

Got it.

Your next question comes from the line of Michael Ng with Goldman Sachs. Your line is open.

Hey, good afternoon. Thank you for the question. It was encouraging to hear about the endorsement of consensus at 26% year-over-year growth. I was just wondering if you could talk about what you're assuming as it relates to AI production deployments, because you did talk about that trial that was underway, and any other areas of optionality that you would call out, perhaps the DIY to branded switches within WebScale, Cloud, and Titans. Any updates there would be helpful. Thank you.

Sure, Michael. As we said, the 7800 is Arista's flagship AI platform. And we have spent the better part of last year, maybe even the year before, Anshul, and you can correct me, doing a tremendous amount of simulation on how we work with GPU clusters and different types of network interface cards, the performance, the lossless, the you know, dealing with bursty traffic, the latency, the transaction. And we believe that this will be a critical year in seeing those trials come into production. So we do expect AI to be meaningful this year as opposed to not material the last couple of years. And we believe the 7800 will be the flagship product for that.

And if I can just answer your other indirect question, your question was, how are we doing against white boxes? We said this before. I think we are maintaining status quo. We're doing very well with our customers. They're not afraid. And we don't believe the market's shifting back to white boxes at all. In fact, the co-development efforts are even more intense than before. But I think, largely speaking, we've achieved status quo. I think that's what the market says for now.

Thanks, Jayshree.

Thanks, everyone. Your next question comes from the line of Alex Henderson with Needham. Your line is now open.

Great. Thanks. I've got a question that I want to split into two pieces. The first one is, as you're looking at market share in the AI arena, does the networking piece, gain share within the AI wallet budgets. And then second, I know that you've had a very significant share advantage in high speed. You've gained significant share from your competitors for every year that I can remember. And I guess the question is, will AI drive an acceleration in your share given the your dominant experience so far in delivering it. So share within the CapEx wallet and then share within the AI market. Two related questions.

Alex, let me go back to your high-speed acceleration question first, and then we'll talk about the market share and AI, because we're still grappling with what is the market for AI right now. In terms of high speed, I think we've now got some killer use cases for 400 and 800 gigs with AI. So you will see our strength going from strength to strength with 100, 200 in some cases, and now 400 and 800 with AI being that killer application driving our high-speed acceleration. We feel more confident of it now. Otherwise, you could argue, you know, what is the use case for 400 and 800 gigs? So that makes us very positive. Specific to AI wallet share, You know, quite honestly, the greatest component of AI today is the processors. That is 80, maybe 90% of the spend. And the applications, obviously, that go with that. So if they're vertically integrated, we may not see as much of it. But if customers choose the horizontal best of breed, we'll absolutely get our share of wallet there.

Great. Thank you so much.

Thank you, Alex.

Your next question comes from the line of Amit Daryanani with Evercore. Your line is now open.

Good afternoon. Thanks for taking my question. I just want to go back to this reduced visibility that you're seeing with the cloud titans. Is it your sense that you just had extra long visibility at four quarters and now it's going back to two quarters, which is normal? Or do you think there's a risk that it actually ends up in an outright pause at some point given you know, these companies did have a really big spending cycle with you in the last four or five quarters already. So I'm just wondering, is this a return to normalcy or do you think there's risk that we end up in a pause with one or both of them the way we did in 2019? Thanks.

Hi, my name is Anshul. You know, our customers have been waiting for two and a half years for this moment where they can return back to normalcy. Supply chain is recovering. These customers follow component details very closely as well. And to a great extent, we're coming back to where we used to be pre-COVID levels, nothing different Nothing more than that.

Next question, please. Your next question comes from the line of Fahad Najam as an independent analyst. Your line is open.

Hey, thank you for taking my question. I wanted to ask you a question on Broadcom's recent introduction of the Jericho 3 AI chip. And it kind of reminds me of the time when they first introduced the Jericho 2 and 2C and you were the earliest adopters of that technology and that led to your significant gains in the leaf spine architecture. So is the Jericho 3 a similar upgrade cycle and should we think about the same advantages you guys are enjoying in this forthcoming cycle as you did in the previous cycle? Anything you can tell us in terms of the comparison?

Father, a good way to look at this market and the introduction of J3, J3 AI, 400 gig is not going to end quickly and suddenly get replaced with Jericho 3. 400 gig will go on for some time. Customers will take time to make changes and so on, especially when they don't need more bandwidth just yet. At the same time, you'll see a quick adoption of 800 gig technology And there's a complimentary chip that was also announced, which is Tomahawk 5. Between Tomahawk 5 and Jericho 3 AI, the AI teams will absolutely consume these as quickly as the market can get them out there. And you may have read some white papers that were also published along with the announcement, which showed that Jericho 3 AI scales to very large clusters. It can scale to 4,000 GPUs quickly. at 800 gig, and the cluster performs at 10% better throughput than InfiniBand. So that is why there's such need for this technology out there, and everyone's anxious to get it. But just remember, the chips have just been announced. It takes time to get the chips, build systems, ship it to customers, go through the trials, and then go to high-volume production.

It's a very exciting multi-year journey, and we really value our partnership with Broadcom. But what you're seeing here is you know, 100 gig for mainstream enterprises, 400 gigs for the cloud, and 800 gig and beyond for AI use cases.

Appreciate the answer. Thank you.

Your next question comes from the line of Matt Nicknam with Deutsche Bank. Your line is open.

Hey, thanks for taking the question. Just to go back to the macro discussion, I'm just wondering, were there any regions, customer verticals where you maybe saw some greater than usual slowness or lengthening sales cycles, particularly later in the quarter? Thanks.

Yeah, Matt, I'd say that usually we see a very strong activity in the month of March. But in Q1, we did see some seasonality in certain regions, especially internationally. And I don't know how one quarter doesn't a trend make, but we're definitely watching this.

Okay, and has that changed at all in early April?

Too early to say. No, you mean has it changed in the sense it's improved in April? Is that your question?

That's right, yeah.

Yeah, April is good so far.

Okay, thank you.

Your next question comes from the line of Michael Genovese with Rosenblatt. Your line is now open.

Thanks for taking the question. Just one question for me. So basically, it's about timing on AI. And when do we think switching will inflect? And I guess maybe the actual question is, what's your outlook on 2024 cloud spending? I mean, we've talked a lot about the next six months, but what about 2024? How are we thinking about that right now? Thank you. Sure.

Can we tell you six months before 2024 spending? Because we don't know. We don't have the visibility.

A little early for that yet, Mike.

But what about on the timing of switches? I mean, as you go through all of this, you know, GPUs or processing units now, training, all of these things, when do you think the timing for switching deployments will inflect positively?

Are you asking specific to AI or cloud-type and spending?

Well, just... Well, specific, you know, I mean, AI is clearly happening now, but, you know, 80% to 90% of the spending is in stuff that you don't do. When do you think that there will be a significant, you know, uptick in that percentage of switching deployments in AI cluster data centers?

Okay. Well, as I said, I think last year was the year of trials. This year we'll see some production, and it'll certainly accelerate in 24 and 25 specific to AI deployments. But again, that's a small spend relative to our larger cloud spend where we'd like to see more visibility on how the cloud regions are getting built out, et cetera.

Thanks for clarifying that distinction. Thank you.

Yeah. Thank you. Your next question comes from the line of James Fish with Piper Sandler. Your line is open.

Hey, ladies. Nice quarter. And nonchalant as well, of course. Purchase commitment, I wanted to circle back there as well. It's moving down as you guys anticipated. But obviously, you guys are a much larger business than you were pre-pandemic. So, I guess, how are you guys thinking about the level of normalcy of purchase commitments as we kind of work through this? And obviously, Ida, you talked about that we'll see sequential impacts to cash flow still on the inventory as we kind of convert that purchase commitment to inventory. Is that something that should reverse then in early 2024? And how should we kind of think about free cash flow conversions for this year then?

Yeah, look, I think if I had my way, the purchase commitment number will come down significantly over the next, I don't know, 12 to 18 months, right? Because we don't need it once we start to see some of these component lead times come in. So we need to, we obviously need to manage that. Some have long lead times that we do want to receive, and you will see that grow in inventory. Some, you know, we'll look to reposition if we can. But obviously there's a keen focus on kind of managing that number now. But the net of it is I think you grow inventory through the year. It will consume some cash, and then it will flip in 2024 where we'll actually start to kind of generate more cash as we start to bring that inventory number down. Do we ever go back to kind of where we were before? I think probably not. I mean, we probably will carry a little bit more inventory and more buffers, having just gone through what we went through the last couple of years. But it should certainly come down from where it is today.

And any thoughts on the free cash flow conversion for the year?

Yeah, I think for this year, inventory is a consumer focus. of cash so it's probably it's hard to know exactly what that looks like but I think every quarter will increment that inventory balance as we go through the year that will consume some cash but I mean the P&L is highly cash positive you know with the guidance that we put out so I think we'll still be generating a healthy amount of cash but we will build inventory balance yeah understood thank you thank you your next question comes from the line of Atai Kidron with Oppenheimer your line is open

Thanks. Hi, ladies. Nice quarter. Ita, I wanted to dig into the comments on gross margin, where you expect them to improve through the year. Two things there. Number one, now the supply chain is getting better. What is it in the supply chain that's still expensive that's hurting you on the gross margin side, and how does that get mitigated? And second, the improvement that you anticipate, is that just a reflection of the mix, meaning cloud perhaps moderating to your point? or is most of the improvement driven, again, by supply chain, better pricing on the supply chain side?

Yeah, I mean, I think in Q1, we were still consuming broker parts and other parts that we had purchased prior, right? Because, I mean, obviously, you have to prepare for the quarter. That should get better in Q2, and then even more so as we go through the rest of the year, where we'll stop consuming those legacy, if you like, broker parts that we have in the pipeline. So that will definitely help. The other thing that's important is now that we don't have the stop start and the decommits and stuff, we can focus on manufacturing, we can focus on driving manufacturing and driving efficiencies there, et cetera. So we should see some improvements come out of that as we go through the year. I'm not assuming a whole lot of a change in the mix of business, maybe a little bit more, but not a lot, just because we have a deployment pipeline for cloud, right? So I think this discussion that we're having about cloud is more you know, when do they need to place orders for the next deployments now that there isn't deployments in front of us right now, right? So I think that's an important distinction, right? So I think we are, you know, we're pretty happy with how the cloud business is kind of plotted out through the rest of the year. The question becomes when do they place new orders with these shorter lead times and when can we see what those new orders will look like?

Thank you.

Your next question comes from the line of Ben Bolin with Cleveland Research. Your line is open.

Good afternoon, everyone. Thanks for taking the question. Edad, I guess more specific for you, could you share any thoughts around OPEX with respect to R&D and sales and marketing and how those have evolved through the year, given the visibility and supply and what you're seeing out there? Thank you.

Yeah, I think we talked about a little bit of the script, but when we are continuing to hire and we are continuing to to make some investments. And we'll, you know, we'll continue to do that. Certainly within the envelope, as we think about the business for the year today, we will continue to do that. It probably doesn't grow quite as fast as the top line. We'll see. But we are continuing to, you know, increment that quarter over quarter and you'll see us continue to grow those investments. And again, it's, you know, it's headcount around R&D and go to market and really, you know, looking for good talent and places where we, you know, where there's opportunity. But we will continue to invest, given the ambit of the business that we have in Bristol.

Thank you.

Your next question comes from the line of Tim Long with Barclays. Your line is open.

Thank you. Can I ask a two-parter on the adjacencies? First, just curious on the campus side, obviously you guys have been growing nicely there. How do you think, and that tends to be more macro sensitive. So how do you view, you know, being able to grow the same level in that sector when there, you know, becomes more macro headwinds like we're starting to see. And then on the routing side, I'm curious now that you're out with the full platform, Jayshree or Anshul, if you could just give us a little view of kind of what feedback has been and what you think the kind of the revenue path would look like for increased routing business. Thank you.

Tim, I think on the campus side, the TAM is somewhere between 10 and 15 billion. So I don't want to make macro an excuse, because I think we have fantastic demand because of our fantastic products. That said, obviously, the way we will see the campus demand manifest is we may see longer decision cycles if the macro continues. But the actual interest in our products is just very solid, very good, because we're still operating. We're still aiming for our first billion here in the next few years, so. So I think we're looking good. On the wind routing, actually, you want to add some comments? It's been a very exciting launch. A lot of demand. It's still too early, right?

And there's lots of disruptions happening in the market, even at the edge, right? When you talk about campuses, talk about what's inside the building, but there's an edge that connects to the outside, too. So we have great interest from our customers in this area. It is a bit too early. We just announced this offering. So too early to jump up and down and say it's lots of numbers yet. We'll watch it as it goes, but having the integrated solution is important to go after the broader enterprise market.

Our existing customers, they see the natural affinity to our Cloud Vision and EOS stack, so that would be the natural spot.

Okay, thank you.

Thank you. Your next question comes from the line of Eric Superger with JMP Securities. Your line is open.

Yeah, thanks for taking the question. Can you speak at least qualitatively about how much backlog you're using up at this point, and how long do you expect to continue working down backlog orders on a quarterly basis?

Yeah, you know I love to talk about backlog, Eric, and I don't think we're going to do that. Look, I think it all comes back to lead times, right? Lead times is the driver of all of this, right? Customers had to place orders to those lead times. As lead times improve, customers order to shorter lead times, and we'll slowly kind of navigate our way back to a more normal visibility window and lead time window, right? I think we're taking the first steps of that now, right? So that's going to take time to get there. But that's what will happen is lead times will naturally bring visibility back to something more normal. But that's going to take some time. And I think we're at the very beginning of that now.

Is that a multi-year process?

I don't know when we're back to normal. It'll take time to get back to normal.

Yeah, we've pretty much said it'll take us the back half of 2023. So I think normal is really next year.

Okay. Thank you.

Okay, thanks, Eric. Your next question comes from the line of Simon Leopold with Raymond James. Your line is now open.

Thanks for taking the question. Just a quick one, if we could get a metric, the RPO value. And in terms of my question, it does seem as if you've had a number of announcements around some software capabilities around your campus and enterprise-focused products. And it feels like you've sort of built up a critical mass. I'm wondering how you look at that strategy in terms of its maturity and its readiness in terms of the software behind the campus portfolio, if there's anything still missing. Thank you.

Yeah, thanks, Simon. I think, you know, most of our software is not standalone software. It's bundled either in Cloud Vision or EOS. There's very few standalone pieces, of course, there's the NDR and the dance monitoring fabric specific to the campus. I would say they tend to look at it more as a solution where they bring in wired wireless. They want an automation framework with cloud vision. They want some security capabilities. In RSA, we announced some of the missing gaps we filled. Historically, we've partnered with other vendors for network access control. And Arista introduced its first one. I'll talk about it more next quarter. But I think some of the gaps we are now starting to fill ourselves. But in the campus, it always tends to be a combination of platforms and software, never standalone software alone.

Yeah, the RSA announcement was actually sort of where my question was coming from. It felt like that was, in my mind, maybe one of the final gaps. And that's what I'm really trying to understand here.

Yeah, I was going to save it for next quarter, but I'll just give you the condensed version. The Arista Guardian for network identity, Agni, means fire in Indian language, Sanskrit. So we'll squelch some of the ice with our fire.

Sounds good. And just the RPO value, do you have that handy?

Yeah, I think it's up about between 50, 60 million quarter over quarter. It did take up a little bit on the software and services side, but not, you know, in that range.

Still small numbers. Long way to go. Yeah. Thank you. Thanks, Sam.

Your next question comes from the line of Sammy Badry with Credit Suisse. Your line is open.

Hi. Two number questions. One is, could you just give us an idea on campus revenues in 1Q23 that's going to trend in 2023? And then for CloudTitans, is that expected to grow, grow double digits? Any kind of reference that you could make for what CloudTitans is going to do for the balance of 2023?

Yeah, I don't think we're going to try to predict the vertical split. I think what we've said is we think our two biggest customers will be at least 10% customers for the year, but that's about all we've really said on that front.

And we feel good about that. They're good partners, and despite all the volatility, we'll have a good year with them. And on campus, I think I gave you a number for $750 million by 2025. I'll stick with that. How about we give that to you towards the end of the year when we really achieve something?

Great. Thank you, David. Operator, we have time for one last question, please.

Your final question today comes from the line of George Notter with Jefferies. Your line is now open.

Hi, guys. Thanks a lot. I guess just following on some of the questions about visibility and customers, any evidence of customers building inventory of your products? whether that's just standalone inventory or whether it's inventory that's maybe installed in the network but not being fully utilized. I guess what I'm really asking is any thoughts about excess inventory rather than just kind of the normal buffers that are out there.

Thanks. I think you... uh asked the question well and you almost answered it it's just normal buffers there's nothing excess in inventory we're seeing nothing abnormal the supply has been so constrained george i mean you're just starting to come on gosh if they have some we'd like to know how they got it thanks so much super thank you this concludes the arisa network's first quarter 2023 earnings call

We have posted a presentation which provides additional information on our results, which you can access on the Investors section of our website. Thank you for joining us today, and thank you for your interest in ERISA. Thank you for joining. Ladies and gentlemen, this concludes today's call.

You may now disconnect.