The toughest thing for a high-growth company to do is sustain its past pace of revenue gains. As a company gets bigger, it gets harder to deliver the same percentage growth year after year. Arista Networks (NYSE:ANET) has started to run into that phenomenon, and even with the high demand for its open-source cloud services, fears about the potential for decelerating growth had weighed on the stock in recent months.
Coming into Thursday's third-quarter financial report, Arista shareholders were anxious for the cloud networking provider to show it could keep itself on track for healthy growth. Arista's results were better than many had foreseen, and accelerating growth could spell another leg up for the company.
How Arista hit the gas
Arista Networks' third-quarter results were encouraging, even to skeptical investors. Revenue was higher by 29%, to $563.3 million, which not only topped the 25% growth rate that most of those following the stock were expecting to see but also accelerated from the 28% top-line gains that Arista achieved in the second quarter. Adjusted net income climbed 34%, to $171.3 million, and the resulting adjusted earnings of $2.11 per share was far higher than the consensus forecast among investors for $1.84 per share.
From a fundamental perspective, Arista has continued to see healthy gains for both key parts of its business. The product side has been extremely important for Arista and there, sales gains of 28% showed the ongoing success of the cloud company's core business. Services have been an important supplement, though, and even stronger segment top-line growth of 36% demonstrated the confidence that clients have in Arista's offerings.
Arista also managed to sustain its operating efficiency for the most part. Gross margin inched up very slightly from year-ago levels, and operating margin sagged by less than a tenth of a percentage point, to 32.1%. Most of the cost increases went toward research and development expenses that hopefully will produce greater technological advances in the future, while sales and market costs rose just 18%, and overhead expenses fell by more than 20%. Only a substantial increase in income tax expenses prevented Arista from seeing gains in profit margin.
CEO Jayshree Ullal was pleased with the performance. "As Arista completes its first decade of customer shipments," Ullal said, "I am proud of the many milestones we have achieved." The CEO highlighted the cumulative shipments of more than 20 million cloud networking ports and gaining entry into the S&P 500 Index as key events in the history of the company.
What's next for Arista Networks?
Arista also was pleased to complete its first two acquisitions. The company picked up Mojo Networks, which should play a key role in expanding its overall cloud networking scope, as well as MetaMako, a leader in low-latency network solutions enabled with field-programmable gate array technology. The introduction of 400-gigabit network platforms also should help the industry deal with the rising demands that users of the cloud want in terms of bandwidth capacity.
Particularly encouraging for investors was Arista's guidance for the coming quarter. The cloud company sees revenue of between $582 million and $594 million for the period, and that range is slightly better than the current consensus forecast of about $586 million among those following Arista. Gross margin projections of 63% to 65% were consistent with previous quarters, but a boost in operating margin to 35% would be 1 percentage point to 3 percentage points higher than the guidance Arista typically has given in the past. That signals some profitability improvements that could carry forward to better performance in the years to come.
Arista shareholders celebrated the news, and the stock soared 10% in after-hours trading following the announcement. With demand for cloud computing solutions showing no signs of slackening, Arista Networks is in a good position to keep delivering the quality and breadth of cloud services that current and prospective clients want to see.