Earnings Call Transcript - ANET Q3 2024

Operator, Operator

Welcome to the Third Quarter 2024 Arista Networks 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. 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.

Liz Stine, Director of Investor Relations

Thank you, operator. Good afternoon, everyone and thank you for joining us. With me on today's call are Jayshree Ullal, Arista Networks Chairperson and Chief Executive Officer; and Chantelle Breithaupt, Arista's Chief Financial Officer. This afternoon, Arista Networks issued a press release announcing the results for its fiscal third quarter ending September 30, 2024. If you would like a copy of this release, it is available 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 fourth quarter of the 2024 fiscal year, longer-term business model and financial outlooks for 2025 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 times, product innovation, working capital optimization, and the benefits of acquisitions 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.

Jayshree Ullal, CEO

Thank you, Liz, and thank you, everyone, for joining us this afternoon for our third quarter 2024 earnings call. We delivered revenues of $1.81 billion for the quarter with a record non-GAAP earnings per share of $2.40. Services and software support renewals contributed strongly at approximately 17.6% of revenue. Our non-GAAP gross margin of 64.6% was influenced by both pressure from cloud titan customer pricing, offset by favorable enterprise margin and supply chain hygiene. International contribution for the quarter registered at approximately 18% with the Americas very strong at 82%. Clearly, Q3 2024 had a lot of bright spots in the quarter and we are encouraged by the strength and momentum of the company. At the recent tenth anniversary in June 2024 celebration and vision event, we covered a lot of ground on what we would have otherwise said in an Analyst Day. So today, I'd like to briefly expand on our Arista 2.0 plans for 2025. We believe that networks are emerging at the epicenter of mission-critical transactions and our Arista 2.0 strategy is resonating well with customers. We are, we believe, the only pure-play network innovator for the next decade. Our modern networking platforms are foundational for transformation from silos to centers of data. This can be a data center, a campus center, a WAN center, or an AI center. At the heart of this is our state-oriented public subscribed network data lake EOS software stack for multimodal data sets. One simply cannot learn without having access to all this data. So it is all about the data. We provide customers the state foundation for data for AI and machine learning without which AI and ML would just be buzzwords. Arista is well positioned with the right network architecture for client to campus, data center, cloud, and AI networking. Three principles guide us and differentiate us in bringing this data-driven networking: best-in-class, highly available proactive products with resilience and hitless upgrade built in at multiple levels; zero-touch automation and telemetry with predictive client-to-cloud one-click operations with that granular visibility that relies less on prescriptive insights for deeper AI for networking delivering AIOps and algorithms for security, availability, and root cause analysis. Networking for AI is gaining a lot of traction as we move from trials in 2023 to more pilots in 2024, collecting thousands of GPUs, and we expect more production in 2025 and 2026. In all vernacular, Arista AI centers are made up of both the back-end clusters and front-end networks. AI traffic differs greatly from cloud workloads in terms of diversity, duration, and size of flow. The fidelity of AI traffic flows with the slowest flow matters, and one slow flow could slow down the entire job completion time, which is a crucial factor in networking. Our AI centers connect seamlessly from the back end to the front end of compute, storage, WAN, and cluster cloud networks. Arista is emerging as a pioneer in scale-out Ethernet accelerated networking for large-scale training and AI workloads. Our new Ethernet portfolio with wirespeed 800-gig throughput and non-blocking performance scales from single tier to session 2 tier networks for over 100,000 GPUs, potentially even 1 million AI accelerators with multiple tiers. Our accelerated AI networking portfolio consists of three families with over 20 switching products and not just one point switch. At the recent OCP in mid-October 2024, we officially launched a very unique platform that distributed Ethalink 7700 to build two-tier networks for up to 10,000 GPU clusters. The 7700 R4 platform was developed in close collaboration with Meta. And while it may physically look like and be cable like a two-tier leased network, it provides a single-stage forwarding with highly efficient spine fabric, eliminating the need for tuning and encouraging fast failover for large AI accelerator-based clusters. It complements our Arista flagship 7800 AI spine for the ultimate scale with differentiated fare and fully scheduled cell spraying architecture with virtual output curing fabric saving valuable AI processor resources and improving job completion time. I would like to now invite John McCool, our Chief Platform Officer, to describe our 2024 platform and supply chain innovations after a challenging couple of years. John, over to you.

John McCool, Chief Platform Officer

Thank you, Jayshree. I'm pleased to report that the Arista 7700 R4 distributed Ecolink switch, the 7800 R4 Spine, along with the 7060 X6 AI leaf that we announced in June have entered into production, providing our customers the broadest set of 800 gigabit per second Ethernet products for their AI networks. Together with 800 gigabit per second parallel optics, our customers are able to connect 400 gigabit per second GPUs to each port, increasing the deployment density over current switching solutions. This broad range of Ethernet platforms allows our customers to optimize density and minimize tiers to best match the requirements of their AI work. As our customers continue with AI deployments, they're also preparing their front-end networks. New AI clusters require new high-speed connections into the existing backbone. These new clusters also increased bandwidth on the backbone to access training data, capture snapshots, and deliver results generated by the cluster. This trend is providing increased demand for the 7800 R3 400-gigabit solution. While the post-pandemic supply chain has returned to predictability, lead times for advanced semiconductors remain extended from pre-pandemic levels. To assure availability of high-performance switching silicon, we've increased our purchase commitments for these key components. In addition, we will increase our on-hand inventory to respond to the rapid deployment of new AI networks and reduce overall lead times as we move into next year. Our supply chain team continues to work closely with planning to best align receipt of these purchases with expected customer delivery. Next-generation data centers integrating AI will contend with significant increases in power consumption while looking to double network performance. Our tightly coupled electrical and mechanical design flow allows us to make system-level design trade-offs across domains to optimize our solutions. Our experience in co-design with the leading cloud companies provides insight into the variety of switch configurations required for these tightly coupled data center environments. Finally, our development operating software with SDK integration, device diagnostics, and data analysis supports a fast time to design and production with a focus on first-time results. These attributes give us confidence that we will continue to execute on our roadmap in this rapidly evolving AI networking segment. Back to you, Jayshree.

Jayshree Ullal, CEO

Thank you, John, and congratulations on a very high performance here to you and your new executives and the entire team. You guys have really done a phenomenal job. Critical to the rapid adoption of AI networking is the Ultra Ethernet consortium specification expected imminently with Arista's key contributions as a founding member. The UEC ecosystem for AI has evolved to over 97 members. In our view, Ethernet is the only long-term viable direction for open standard-based AI networking. Arista is building holistic AI centers powered by our unparalleled superiority and the depth of automation and visibility software provided by CloudVision. Arista EUS delivers dynamic methods using cluster load balancing for congestion control and smart system upgrades where the traffic for AI continues to flow in the midst of an upgrade. Arista continues to work with AI accelerators of all types and we're agnostic to niche to bring advanced EOS visibility all the way down to the host. Shifting to 2025 goals. As we discussed in our New York Stock Exchange event in June, our TAM has expanded to $70 billion in 2028. And you know we've experienced some pretty amazing growth years with 33.8% growth in '23, and 2024 appears to be heading at least to 18%, exceeding our prior predictions of 10% to 12%. This is quite a jump in 2024, influenced by faster AI pilots. We are now projecting an annual growth of 15% to 17% next year, translating to approximately $8 billion in 2025 revenue with a healthy expectation of operating margin. Within that $8 billion revenue target, we are quite confident in achieving our campus and back-end networking targets of $750 million each in 2025 that we set way back 1 or 2 years ago. It's important to recognize though that the back end of AI will influence the front-end AI network and its ratios. This ratio can be anywhere from 30% to 100%, and sometimes we've seen it as high as 200% of the back-end network depending on the training requirements. Our comprehensive AI center networking number is therefore likely to be double our back-end target of $750 million, now aiming for approximately $1.5 billion in 2025. We will continue to aim for double-digit annual growth and a 3-year CAGR forecast of teams in the foreseeable future of 2024 to 2026. More details forthcoming from none other than our Chief Financial Officer. So, over to you, Chantelle.

Chantelle Breithaupt, CFO

Thank you, Jayshree. Turning now to more detail on the financials. This analysis of our Q3 results and our guidance for Q4 fiscal year '24 is based on non-GAAP, it excludes all noncash stock-based compensation impacts, intangible asset amortization and other nonrecurring items. A full reconciliation of our selected GAAP to non-GAAP results is provided in our earnings release. Total revenues reached $1.81 billion, marking a 20% year-over-year increase. This strong performance exceeded our guidance range of $1.72 billion to $1.75 billion. Services and subscription software contributed approximately 17% of revenues in the third quarter. International revenues for the quarter came in at $330.9 million, or 18.3% of total revenue, down from 18.7% last quarter. This quarter-over-quarter decrease reflects an increased contribution from domestic shipments to our cloud and enterprise customers. Overall, gross margin in Q3 was 64.6%, above the upper range of our guidance of approximately 64%, down from 65.4% last quarter and up from 63.1% in Q3 prior year. This year-over-year improvement is driven by stronger enterprise margins and supply chain discipline in the current quarter. Operating expenses in the quarter were $279.9 million or 15.5% of revenue, down from last quarter at $319.8 million. R&D spending came in at $177.5 million or 9.8% of revenue, down from $216.7 million last quarter. An item of note is that there were additional R&D-related expenses originally expected in Q3 that are now expected to materialize in the Q4 quarter. R&D had increased low double-digit percentages versus Q3 in the prior year. Sales and marketing expense was $83.4 million or 4.6% of revenue, down slightly from last quarter. Our G&A costs came in at $19.1 million or 1.1%, similar to last quarter. Our operating income for the quarter was $890.1 million or 49.1% of revenue. This was favorably impacted by the shift of R&D-related expenses from Q3 now anticipated in Q4 of this year. Other income and expense for the quarter was a favorable $85.3 million, and our effective tax rate was 21.1%. This resulted in net income for the quarter of $769.1 million or 42.5% of revenue. Our diluted share number was 320.5 shares, resulting in a diluted earnings per share number for the quarter of $2.40, up 31.1% from the prior year. This was favorably impacted by the shift in R&D-related expenses from Q3 to Q4. Now, turning to the balance sheet. Cash, cash equivalents, and investments ended the quarter at approximately $7.4 billion. In the quarter, we repurchased $65.2 million of our common stock at an average price of $318.40 per share. Of the $1.2 billion repurchase program approved in May 2024, $1 billion remains available for repurchase in future quarters. The actual timing and amount of future repurchases will be dependent upon market and business conditions, stock price, and other factors. Turning to operating cash performance for the third quarter, we generated approximately $1.2 billion of cash from operations in the period, reflecting strong earnings performance combined with favorable working capital results. DSOs came in at 57 days, down from 66 days in Q2, reflecting a strong collections quarter combined with contributions from linearity of billing. Inventory turns were 1.3x, up from 1.1% last quarter. Inventory decreased to $1.8 billion in the quarter, down from $1.9 billion in the prior period, reflecting a reduction in our raw materials inventory. Our purchase commitments and inventory at the end of the quarter totaled $4.1 billion, up from $4 billion at the end of Q2. We expect this number to continue to have some variability in future quarters as a reflection of demand for our new product introductions. Our total deferred revenue balance was $2.5 billion, up from $2.1 billion in Q2. 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 $320 million versus last quarter. Fiscal 2024 continues to be a year of new product introductions, new customers, and expanded use cases. These trends have resulted in contracts with customer-specific acceptance clauses, and will continue to increase the variability in magnitude of our product deferred revenue balances. Accounts payable days were 42 days, down from 46 days in Q2, reflecting the timing of inner receipt payments. Capital expenditures for the quarter were $7 million. In October, we began our initial construction work to build expanded facilities in Santa Clara and we expect to incur approximately $15 million during Q4 for this project. Now, turning to the fourth quarter. Our guidance for the fourth quarter which is based on non-GAAP results and excludes any noncash stock-based compensation impacts, intangible asset amortization, and other nonrecurring items is as follows: Revenues of approximately $1.85 billion to $1.9 billion, gross margin of approximately 63% to 64%; operating margin of approximately 44%. Our effective tax rate is expected to be approximately 21.5% with diluted shares of approximately 321 million shares on a pre-split basis. On the cash front, while we have experienced good increases in operating cash over the last couple of quarters, we anticipate an increase in working capital requirements in Q4. This is primarily driven by increased inventory in order to respond to the rapid deployment of AI networks and to reduce overall lead times as we move into 2025, mentioned in John's prepared remarks. We will continue our spending investment in R&D, go-to-market activities, and scaling the company. Additionally, in Q4 as part of our ongoing commitment to creating long-term value for our shareholders and enhancing the accessibility of our stock, we are pleased to announce that Arista's Board of Directors has approved a 4-for-1 stock split. This decision reflects our confidence in the continued growth and prospects of the company. It's important to note that while the stock split increases the number of shares outstanding, it does not change the intrinsic value of the company nor does it impact our financial performance or strategy. The split is designed to make our stock more accessible and attractive to a wider range of investors, particularly retail investors which we believe will ultimately support broader ownership and improve trading dynamics. Transitioning now to fiscal year 2025. As Jayshree mentioned, we are projecting revenue growth of 15% to 17%. The expected revenue mix is forecasted to have an increased weighting of cloud and AI customers, placing the gross margin outlook at 60% to 62% and operating margin at approximately 43% to 44%. Our commitment remains to continue to invest in R&D, go-to-market, and the scaling of the company as we forecast reaching approximately $8 billion in revenue in 2025. We reiterate our double-digit growth forecast in the foreseeable future and a 3-year revenue CAGR goal of mid-teens for fiscal year '24 through '26. We are excited by the current and future opportunities to serve our customers as the pure-play networking innovation company and to deliver strong returns to our shareholders. I will now turn the call back to Liz.

Liz Stine, Director of 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, Operator

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

Samik Chatterjee, Analyst

I see a strong set of results, but I'd like to ask about the guidance. Jayshree, you mentioned a target of $750 million for TI and stated that you're also aiming to meet your campus revenue target. Considering these two points, it seems that the non-AI and non-campus business may only be experiencing single-digit growth next year. This follows a period of double-digit growth in 2024, where we accounted for backlog digestion in 2023. Can you provide some insight into why there appears to be a significant drop in the non-AI, non-campus business based on these numbers? What do you believe is influencing this outlook?

Jayshree Ullal, CEO

Thank you, Samik. As you know, our visibility only extends to roughly about 6 months, right? So we don't want to get ahead of ourselves on how much better we can do and that's kind of how we started 2024 either, and we were pleasantly surprised with the faster acceleration of AI pilots. So we definitely see that our large cloud customers are continuing to refresh on the cloud but are pivoting very aggressively to AI. So it wouldn't surprise me if we grow faster in AI and faster in campus in the new center markets and slower in our classic markets, called that data center and cloud. And this is the best we can see right now. It doesn't mean we couldn't do better or worse. But as far as our visibility goes, I think this represents a nice combination of all our different customer segments and all our different product sectors.

Operator, Operator

Our next question comes from the line of Antoine Chkaiban with New Street Research.

Antoine Chkaiban, Analyst

Can you maybe provide an update on the four major AI trials that you gave in the past? How are things progressing versus your expectations as of 90 days ago? And when do you expect the move to production to happen? And what kind of scale are we talking about?

Jayshree Ullal, CEO

That's a good question. Arista now believes we're at five out of five instead of four out of five. We are making significant progress in four out of the five clusters. Three customers are transitioning from trials to pilots this year, and we anticipate that these three will develop into 50,000 to 100,000 GPU clusters by 2025. We're also excited about the new Ethernet trial in 2024 with our fifth customer. This customer has historically relied heavily on InfiniBand, and we are currently in a trial phase with them in 2024, hoping to move to pilots and production soon. Three customers are doing well; one is in the initial stages, while the fifth customer is progressing slower than we anticipated. They may recover in 2025, and we will keep you informed. However, if they don't, we remain optimistic about our guidance for 2025. Is that correct, Chantelle?

Operator, Operator

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

Tal Liani, Analyst

NVIDIA in the last quarter launched the Spectrum X, it shows that in data center switching their market share went from like 4% to 15%. Does it mean that you're seeing increased competition from NVIDIA? And is it competing with you on the same spot? Or is it more competing with white boxes? And the second question is about white boxes. What is the outlook for white box participation in Gen AI? Is it going to be higher or lower than in front-end data centers?

Jayshree Ullal, CEO

Okay, thanks, Tal. Which question do you want me to answer?

Tal Liani, Analyst

Let's go with NVIDIA. Give me the gift of...

Jayshree Ullal, CEO

We consider NVIDIA to be a valuable partner. Without the ability to connect to their GPUs, we wouldn't be experiencing the current demand for AI networking. We appreciate NVIDIA and Jensen for this partnership. It's worth noting that NVIDIA offers a comprehensive solution, mostly featuring InfiniBand, though they do have some Ethernet capabilities following their acquisition. However, we don't frequently encounter their Ethernet offerings, only with one or two customers. Arista is recognized as the expert in this area, with a complete portfolio and software solutions. Whether it's large-scale Ethernet networking for major companies or smaller enterprises, we are seeing increased activity in the GPU plus enterprise segment, where Arista is regarded as the authority. That said, we do not expect to win every opportunity. We embrace NVIDIA as a partner in some areas while acknowledging them as a strong competitor in Ethernet switching.

Operator, Operator

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

Simon Leopold, Analyst

I'll tag team with Tal. So we'll partner once again here. I do want to sort of look at this competition or competitive landscape broadly. In that what I'm trying to understand is how it may be changing with the advent of AI, to not just hearing from you about white box but also competitors like Cisco and Juniper and Nokia. So really an update on the competitive landscape would be helpful.

Jayshree Ullal, CEO

Thank you, Simon. That's a broad question. Since you specifically asked about AI rather than cloud, let me break this down into two parts: the back end and the front end. On the back end, we are directly connecting to GPUs. Often, this goes unnoticed because it gets blended into the GPU, especially with NVIDIA. A year ago, I mentioned we were on the outside looking in since most bundling occurs internally. I expect that any market share Arista captures, including that $750 million, is completely new for us since we weren’t there before. We welcome all opportunities, but we do not claim to be a market leader in that area. Instead, we recognize that there are established players with InfiniBand and various Ethernet versions, and Arista seeks to build more credibility and experience to become the gold standard for the back end. On the front end, we are often regarded as the gold standard in a highly complex network environment. Implementing a leaf-spine architecture involves a significant amount of scale with L2, L3, EVPN, VXLAN, visibility, telemetry, and automation routing at scale, along with encryption requirements. Our accelerated networking portfolio enhances NVIDIA's accelerated compute portfolio. Compared to our competitors, we possess the best portfolio of 20 switches across three families, and our capabilities and competitive edge are unmatched. I am aware of some instances where AI applications are not operating on certain industry peers’ products, and they are interested in switching to ours. I am very optimistic about our 7,800 flagship product and the newly launched 700, which we developed in close collaboration with Meta, particularly the 7060; this product line is primarily running at 400 gig as the ecosystem has not fully adopted 800 yet. However, as we move towards 800, John and the team are preparing the supply chain for that transition. Competitively, we are performing exceptionally well on the front end, while our back end growth is incremental. Overall, I would describe our performance in AI as a significant evolution from where we were 12 years ago to our current position.

Operator, Operator

Our next question comes from the line of Ben Reitzes with Melius Research.

Ben Reitzes, Analyst

I wanted to ask a little bit more about the $750 million in AI for next year. Has your visibility on that improved over the last few months? I wanted to reconcile your comment around the fifth customer not going slower than expected. And it sounds like you're now in 5 on 5, but wondering if that fifth customer going slower is limiting upside or limiting your visibility there? Or has it actually improved and it's gotten more conservative over the last...

Jayshree Ullal, CEO

Somebody has to bring a conservative end, but I think we're being realistic. So I think you said it right. I think on three out of the five, we have good visibility at least for the next 6 months, maybe even 12. John, what do you think?

John McCool, Chief Platform Officer

Yes.

Jayshree Ullal, CEO

On the fourth one, we are in early trials, and we got improving to do. So let's see, but we're not looking for 2025 to be the bang-up year on the fourth one. It's probably 2026. And on the fifth one, we're a little bit stalled which may be why we're being careful about predicting how they'll do. They may step in nicely in the second half of '25, in which case, we'll let you know. But if they don't, we're still feeling good about our guidance for '25. Is that right, Chantelle?

Chantelle Breithaupt, CFO

I totally agree. It's a good question, Ben. But I think out of the five the way Jayshree categorized them, I would completely agree.

Operator, Operator

Our next question comes from the line of Karl Ackerman with BNP Paribas.

Karl Ackerman, Analyst

Jayshree, could you discuss whether the programs are engaged with on hyperscalers? Will it be deploying your new Ethalink switches and AI spine products on 800-gig ports? In other words, have these pilots or trials been on 400 gig and production beyond 800 gig? And I guess if so, what's the right way to think about the hardware mix of sales of 800 gig in '25?

Jayshree Ullal, CEO

Yes. That's a good question. I mean, just going back to again, it was always hard to tell that 100 and 400 because somebody can take their 400 and break it into breakouts of 100. So I would say today, if you ask John and I, a majority of the trials and pilots are on 400 because people are still waiting for the ecosystem at 800, including the NIC and the UEC and the packet spring capabilities, et cetera. So while we're in some early trials on 800, the majority is 400. Majority of 2024 is 400 gig. I expect as we go into '25, we will see a better split between 400 and 800.

Operator, Operator

Your next question comes from the line of Ryan Koontz with Needham & Company.

Ryan Koontz, Analyst

I was hoping we could touch base on your campus opportunities a bit. Where are you seeing the most traction in terms of your applications? Is this primarily from your strength in kind of core moving big bits around the campus core or are you seeing WiFi? Can you maybe just update us on the campus applications and verticals you're seeing the most traction in?

Jayshree Ullal, CEO

Yes. Ryan, let me take a step back and say that our enterprise opportunity has never been stronger. As a focused innovator, we are increasingly being invited into enterprise deals, even though we sometimes lack the sales coverage for it. What I mean is that Arista is being sought for a network design that avoids multiple operating systems and different silos. There’s considerable competitive fatigue, and many of our industry peers are exploring other areas, such as observability or integration of various products. Our enterprise opportunity isn’t just limited to data centers; it also includes campus centers, WAN centers, and some elements of AI. Now, addressing your campus question more specifically, one of the first developments in our campus strategy is the universal spine. Customers see the advantage of using the same spine in both data centers and campuses, which has led to increased interest. A significant part of our $750 million projection is based on the confidence they have in this platform and foundation, positioning them well for future spine deployments. If Sanjay Kumar, our VP and GM for Campus, were here, he would emphasize the importance of measuring the edge ports, including power Ethernet, wired connections, and WiFi, which is crucial for our strategy.

John McCool, Chief Platform Officer

Sanjay Kumar.

Jayshree Ullal, CEO

Yes. And so he would say, you got to get that right. And so number one, we're in the spine; two, we're making stronger progress on the wired. Our weakest partly because we are data center folks and we're still learning how to sell radio is the WiFi that we plan to fix that and this is where the extra coverage will come in. So I would say more of our strength is coming into wired and spine. We are doing very well in pockets of WiFi, but we need to do better. Chantelle, you want to add something?

Chantelle Breithaupt, CFO

Just to take the second part, I think you were asking about some of the verticals in your question. I just wanted to add some of the verticals. I think where we're seeing some strength is data center and campus. I would say financials, health care, media, retail, Fed, and sled.

Jayshree Ullal, CEO

Yes, Fed and sled; that's a good one. This is historically an area we have not paid attention to. The federal market, we're getting very serious about, including setting up its own subsidiary. So Chantelle, you've been a huge part of pushing us there. So, thank you.

Operator, Operator

Our next question will come from the line of Amit Daryanani with Evercore.

Amit Daryanani, Analyst

I guess I'm hoping you could spend some time on the sizable acceleration we're seeing both on your total deferred number, but also the product deferred number is going up pretty dramatically. Jayshree, historically, when product defaults go up in such a dramatic manner, you actually end up with really good revenue in the out years. And you're guiding for revenue that you decelerate in '25. Maybe just help me connect like what's the delta, why product different what's making the acceleration that we historically have seen?

Jayshree Ullal, CEO

I'm going to let Chantelle, the expert answer the question, but I will say one line. Remember, in the case of those examples you're quoting, the trials were typically, I don't know, 6 to 12 months; this can be multiple years and can take a lot longer to manifest. It may not all happen in 2025. Over to you, Chantelle.

Chantelle Breithaupt, CFO

I think, yes. So thank you, Jayshree. So part of it is the type of use case, the type of customers, the mix of product that goes in. They all have bespoke time frames, as Jayshree referred to. You're starting to see those lengthen. And the other thing too is that this is what we know now; as you move through every quarter, there are deferred in and out. So this is what we know at this time. And it's a mix of the variables that we told you before. And then as we move through '25, we'll continue to update.

Operator, Operator

Our next question will come from the line of Meta Marshall with Morgan Stanley.

Meta Marshall, Analyst

Jayshree, I wanted to understand your thoughts on adding other Tier 2 opportunities or sovereigns, and how you see these additional customers who are heavily investing in AI developing as opportunities for Arista.

Jayshree Ullal, CEO

This is a good question. So we're not saying these are the only trials. But these are the five we predict can go to 100,000 GPUs and more. That's the way to look at this. So there are largest AI titans, if you will, and they can be in the cloud, hyperscale Titan group; they could be in the Tier 2 as well, by the way. Very rarely would they be in a classic enterprise. By the way, we do have at least 10 to 15 trials going on in the classic enterprise too, but they're much smaller GPU counts, so we don't talk about it. So we're folding on the big five to the point that they really skew our numbers and they're very important to establish our beachhead, our innovation, and our market share in AI, but there's definitely more going on. In terms of specifically your question on Tier 2 and whether there will be more there, there will be more. But these are the five we see in that category, and they're spread across both the Tier 1 Titan Cloud as well as Tier 2.

Operator, Operator

Our next question comes from the line of Sebastien Naji with William Blair.

Sebastien Naji, Analyst

Yes. Just specifically on the Ethernet or Etherlink portfolio, could you maybe rank order or comment on what you see as the opportunity across each of the three families: a single-tier, lease spine, and then the tolling switch as we're going into 2025 and beyond?

Jayshree Ullal, CEO

I'll give it a try, but John, please jump in because this is definitely an estimate. It might be better to say no comment, but we’ll do our best to provide some insight. Regarding the Etherlink, the fixed 7060 switches are quite popular in terms of units since it's a single switch that our customers know well. This success stems from a strong partnership with Broadcom, as we have developed Tomahawk versions 1 through 5. So volume-wise, that's the standout. On the other hand, while the 7800 may have lower volume, it is highly strategic in terms of revenue, and we believe it offers a competitive advantage as we collaborate with Broadcom on the Jericho and other families. Would you call this a real flagship, John?

John McCool, Chief Platform Officer

Yes, that’s right.

Jayshree Ullal, CEO

In dollars, that's the significant one. The 7700 offers the best of both worlds, combining the capabilities of the 7800 in a compact form that supports up to 10,000 GPUs. It's brand new and should stand out competitively, as no one else offers this with a scheduled fabric in a single stage. We developed this in close collaboration with Meta, working together for about 18 months to 2 years. While we might not know everything about how to qualify it yet, it shows great potential and could be a fast accelerator in the coming years.

John McCool, Chief Platform Officer

Yes, I can.

Jayshree Ullal, CEO

Just to add to that, John?

John McCool, Chief Platform Officer

7700; yes, people are interested in the very large scale is attractive for the 700. Between the 7060 and the 7800, we do see people that are optimizing a mix of both of those products in the same deployment so they can get the minimum number of tiers but have the maximum amount of GPUs that fit their use case. So we do see a lot of tailoring now around the size of the deployments based on how many GPUs they want to deploy in their data center.

Jayshree Ullal, CEO

Yes, that's a really good point. And then suddenly, they'll go, okay, I want to go from a four-way rates to an eight way. And then suddenly, you have to add more line cards in your 7800, and come running to you for more supply chain.

Operator, Operator

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

Aaron Rakers, Analyst

I wanted to transition from the competitive landscape and ask about your 2025 outlook and the midterm model you provided. It appears that you're anticipating some margin declines. What factors are driving these expectations for gross margin decreases? Is it related to the customer mix? Do you foresee multiple customers contributing over 10% in 2025? Any insight into how those margin expectations were determined would be appreciated.

Chantelle Breithaupt, CFO

I would say, absolutely and the outlook that you referred to, it is customer mix. We're expecting John to continue the great supply chain discipline that he's been doing with his team. So it is a big comment only. And as for the 10% customers, I would say the one dynamic, maybe it's a bit cheeky to say it as the denominator gets bigger, that gets a bit tougher. So we'll see as we go in the out years. But right now, we'll just keep to the sort of the ones that we currently talk about, and we'll see how that goes from '25 and '26.

Jayshree Ullal, CEO

It's going to get harder and harder to have 10 customers. So I believe M&M will still be that in 2025, but I don't anticipate there are any others at the moment.

Liz Stine, Director of Investor Relations

Operator, we have time for one last question.

Operator, Operator

Our final question will come from the line of Atif Malik with Citigroup.

Atif Malik, Analyst

Jayshree, some of the recent conferences, you've talked about every dollar spent on back end is at least 2x on the front end. What signs are you looking for to see the lift from AI on the front end or classic cloud from the pressure on the bandwidth?

Jayshree Ullal, CEO

Yes, I believe it all depends on their approach to AI. If they aim to develop a back-end cluster and validate something, they typically focus on achieving the highest job training completion and robust training models, which represents a very limited application. However, we're increasingly noticing that for every dollar invested in the back end, there can be an additional 30%, 100%, or even 200% spent, which is why we anticipate that the $750 million will carry over into next year, along with an additional $750 million on front-end traffic that will include AI and other components, not exclusively AI. Therefore, I wouldn't be surprised if that figure falls between 30% and 100%, with the average being 100%, effectively doubling the back end overall. I feel quite optimistic about this. However, it’s challenging to precisely quantify that as purely AI, which is why I mention that as more inference, training, front-end, storage, WAN, and traditional cloud converge, the pure AI figures become harder to track.

Liz Stine, Director of Investor Relations

Thanks so much, all. This concludes the Arista Networks third quarter 2024 earnings call. We have posted a presentation that 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 Arista.

Operator, Operator

Thank you for joining. Ladies and gentlemen, this concludes today's call. You may now disconnect.