Arista Networks (ANET 9.06%) has been a bit player in the fast-growing cloud computing space for a long time, with users gravitating to its open-source paradigm and choosing its services over those of its competitors. Arista has managed to keep its growth rate healthy for a long time, and thus far, it's been able to defy naysayers who predicted that the party would come to an end eventually.
Yet once again, fears of slowing growth are creeping into investors' minds, and this time, it's Arista that put them there. Coming into Thursday's first-quarter financial report, Arista shareholders were ready to predict strong growth rates well into the future. Yet even though Arista had good results for the quarter, its guidance for future sales points to the possibility of a substantial slowdown that has many questioning its long-term strategy.
Solid results for Arista
Arista Networks' first-quarter results showed no real signs of weakness. Sales of $595.4 million were up 26% from the year-ago quarter, almost exactly matching what most of those following the stock had expected from the network specialist. Adjusted net income of $187.7 million climbed an even stronger 40% over the same period, and adjusted earnings of $2.31 per share far exceeded the $2.07 per-share consensus forecast among investors.
Looking at Arista's segments, the two primary divisions showed performance that was consistent with past quarters. Sales of products were up 24%, matching last quarter's growth rate. The services sector continued to outperform, with gains of 39% in revenue falling back from the fourth quarter of 2018's stronger gains, but still maintaining an impressive pace.
Last quarter's numbers raised some concerns about margin levels, but Arista's numbers didn't have the same features this time around. Adjusted gross margin inched higher by a tenth of a percentage point from year-ago levels, to 64.5%, and measured gains in operating expenses helped to boost profitability considerably.
CEO Jayshree Ullal didn't have any qualms about the report. "Arista's Q1 results demonatrate our consistent execution and profitability," Ullal said, "despite the seasonality of the quarter." We are witnessing the deployment of cloud principles into new enterprise markets."
What's scaring Arista investors?
Arista's highlights during the quarter suggested continued growth opportunities. The disruptive 7360X series open cloud-scale platform should allow users to cut costs while doubling system density, allowing for migration to new 100- and 400-gigabit architecture while still using Arista's key EOS cloud network operating system. Meanwhile, a new network application platform combines high precision with ultra-low levels of latency, leading to better overall performance.
Yet the bombshell that sent Arista investors into a panic was its guidance for the second quarter. The company set revenue projections at just $600 million to $610 million, implying a growth rate of just 15% to 17% for the period. Compared to consensus forecasts among investors for around $640 million -- or a 23% growth rate that would be consistent with the longer-term top-line growth trend -- Arista's numbers were unexpectedly bad.
In the conference call, Ullal gave more color on the situation. As she explained:
We are experiencing somewhat of a speed bump in Q2 2019. We saw less than normal order strength in late March and the month of April. We are therefore expecting slow growth in Q2 2019 from our normal and historical patterns. ... In particular, one cloud titan has placed most orders on hold for Q2.
Perhaps in anticipation of the negative reception to the guidance, Arista also announced a $1 billion stock repurchase program. That works out to between 4% and 5% of the company's current market capitalization, and Arista gave itself a three-year period in which to use the buyback authorization.
Arista shareholders did not like to see that the end of the company's fastest growth phase might be coming to an end, and the stock plunged 16% in after-hours trading following the announcement. Going forward, Arista will have to prove its CEO's assertion that healthy momentum in the enterprise segment will eventually lead to restored and accelerating growth. Otherwise, what Arista sees as a critical period for customer acceptance of its products could bring more trouble during the rest of 2019.