Cloud networking has become a must-have capability for a wide range of businesses, and Arista Networks (NYSE:ANET) has sought to meet high demand from customers looking to simplify their information technology footprint and take advantage of cloud-based services. With all the hype about the industry, companies providing those services need to show that they're benefiting from the positive trends toward the cloud, and coming into Thursday's third-quarter financial report, Arista investors wanted to see signs of ongoing strength. Arista's results were more than sufficient on that score, and the company said it expects even better times ahead. Let's take a closer look at how Arista Networks did and what it sees in its future.
Arista soars into a cloud-filled sky
Arista Networks' third-quarter results continued to show extraordinary growth. Sales jumped by a third to $290.3 million, which was slightly faster than the ambitious 30% growth rate that investors wanted to see. On the bottom line, adjusted net income was up 44% to $61.2 million, and that produced adjusted earnings of $0.83 per share. That figure was $0.10 per share higher than the consensus forecast for earnings among those following the stock.
Looking more closely at Arista's financial numbers, most of the trends that we've seen in previous quarters remained in place. Product-based revenue was up by more than 30% and continued to drive the bulk of the gains in Arista's revenue. However, the services segment boosted its sales at a pace approaching 50%. As we've seen in previous quarters, the rise in sales put some pressure on gross margin, which dropped overall by nearly a full percentage point to 64.2%.
Arista continues to do an excellent job of keeping costs in check. Substantial reductions in overhead expenses helped offset rising costs in the research and development and sales and marketing areas, and overall, Arista's total operating expenses rose just 12%. That helped drive the company's large bottom-line gains.
CEO Jayshree Ullal was happy about milestones that Arista has achieved. "I am pleased with our record third quarter 2016 earnings," Ullal said, "and our cumulative shipments of 10 million cloud networking ports. These milestones highlight Arista's customer enthusiasm for our new 7000 series products and the inevitable shift from legacy to cloud networking."
Can Arista keep growing?
Arista's guidance for the fourth quarter was also encouraging, giving investors a reasonable expectation that the company's outperformance can continue. Arista said that it expects to generate between $310 million and $320 million in revenue during the fourth quarter, and that range is above the current consensus forecast among investors for the period. The company believes that adjusted gross margin will be between 61% and 64% and adjusted operating margin will be about 26%, and those numbers are consistent with what investors have been used to seeing from Arista.
One area that Arista hopes will generate more growth involves a new strategic partnership with Hewlett-Packard Enterprise (NYSE:HPE). The agreement broadens the existing relationship between Arista and Hewlett-Packard Enterprise, giving Hewlett-Packard Enterprise customers the ability to purchase switching products made by Arista Networks directly from HP Enterprise. With what Arista termed "a common vision of secure hybrid IT solutions and experiences built on industry-leading software-defined infrastructure," the company hopes that Hewlett-Packard Enterprise will help it broaden its customer base and offer complete solutions to clients.
Even with the strong results, Arista Networks investors didn't immediately react positively to the news, sending the stock down about 2.5% in after-hours trading following the announcement. Nevertheless, if Arista can keep taking full advantage of the opportunities that the cloud is giving it right now, then future growth in its fundamental business should continue to impress long-term shareholders in the years to come.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Arista Networks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.