Shares of data center supplier Arista Networks (ANET +2.86%) have rocketed to new all-time highs this year. The stock price is up more than 75% year-to-date in 2021, including a 25% surge following the company's third-quarter update on Nov. 1.
As a supplier of hardware for data center construction, supply chain issues were sure to crop up and hit Arista -- and management did indeed expound on some of the problems it's facing right now. But demand for its wares is strong enough right now that it did little to rain on the parade.
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Not just hardware, but also software
Arista CEO Jayshree Ullal started off the Q3 earnings call Monday by addressing supply chain issues, calling it an "acute supply chain crisis." Lead times for orders have increased dramatically, as have prices on parts. Some component price hikes have skyrocketed by triple-digit percentages this year as Arista's manufacturing partners pass on shipping and raw material costs. Arista is, in turn, passing on some of these costs to its cloud computing customers, implementing about a 10% increase in pricing effective Nov. 4.
These supply chain problems clearly aren't an insurmountable problem, though. Total revenue in Q3 2021 increased 24% year over year to just shy of $749 million. This reflects two things. First, Arista was still down in the dumps this same time last year, deeply impacted by the pandemic as many of its customers temporarily halted spending on data centers. And second, Arista is now experiencing a surge in demand from many of these customers, a potential outcome it foresaw early this year and had already begun planning for.
In spite of supply chain problems, Arista's gross profit margin on products and services sold was a very healthy 63.9%, compared to 64.2% three months ago, and still within management's long-term expectation for gross margin to remain within the 63%-to-65% range. Helping boost this figure is software and services, which made up about one-fifth of total sales in Q3 (including cloud security and data center management software). That segment grew 15% year over year but generated a gross margin of over 81%.
Q3 wasn't a perfect quarter, but Arista is managing shipping and pricing problems and still putting up solid numbers as it rebounds from the effects of the pandemic.
Extending lead times well into 2022
The best businesses aren't just able to weather storms, they can also improve on their processes as a result of crises. Though there are difficulties right now, Arista may come out of this stress test stronger than ever. The company is improving the quality of its supply chain and customer order planning as a result of the constraints put upon it by part manufacturers and shipping issues this year.
Ullal expounded on the earnings call that, because of increased lead times for component orders, the company is able to plan further into the future than it ever has before. For example, Arista used to have about a quarter or two of visibility into cloud titan customers' (think Microsoft's Azure and Amazon's AWS cloud computing segments) data center spending. Now, lead times have pushed that visibility out to a year or more. For other enterprise customers, six months or more lead time is occurring.
The result is that Arista is able to plan and build up inventory for orders well into 2022 and beyond. Besides being able to prepare well in advance of actual orders, it also gives Arista some insight into future financial performance in what has become a volatile industry. The company's top team is confident enough in its trajectory that it added a new $1 billion share repurchase authorization, currently worth about 2.5% of Arista's market capitalization.
As for financial outlook, Q4 2021 expectations for revenue of $775 million to $795 million imply year-over-year growth of 19% to 22%. Adjusted operating profit margin will also remain very healthy at about 37%.
A new boom in data center spending is underway to support cloud computing services, and Arista is a prime beneficiary. It's being dealt a difficult hand right now with supply chain issues, but the company is more than just coping with the problem. This remains one of my favorite bets on cloud infrastructure, even after the fantastic run the stock has had so far this year.
