Arista Networks, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; comparisons are with Q1 2014 unless otherwise noted. Arista sells cloud-networking switches and related software and support services. Amounts below are in U.S. dollars; financial statement figures are in millions except per-share data.
Financial performance and liquidity
| Metric | Q1 2015 | Q1 2014 / comparison |
|---|---|---|
| Revenue | $179.0 | $117.2; up 52.8% |
| Product / service revenue | $160.1 / $18.9 | $106.5 / $10.7; up 50.4% / 76.4% |
| Gross profit; gross margin | $117.8; 65.8% | $81.3; 69.4% |
| Operating income; operating margin | $35.8; 20.0% | $22.0; 18.8% |
| Net income; net margin | $24.5; 13.6% | $12.3; 10.5% |
| Diluted EPS | $0.34 | $0.20 |
| Operating cash flow | $20.8 | $17.7 |
| Cash and cash equivalents, March 31 | $275.2 | $240.0 at Dec. 31, 2014 |
| Marketable securities, March 31 | $209.2 | $209.4 at Dec. 31, 2014 |
| Total liabilities; financing lease obligation | $264.6; $43.4 | $255.4; $43.6 at Dec. 31, 2014 |
Cash, cash equivalents and marketable securities totaled $484.3 million at quarter-end, including approximately $100.7 million held outside the U.S. Management said existing liquidity and operating cash flow should fund working capital and growth plans for the foreseeable future. The filing reports a lease financing obligation but no outstanding conventional borrowings at quarter-end. Current assets were $736.0 million and current liabilities $148.3 million.
Cash increased $35.2 million during the quarter: operating activities provided $20.8 million, investing used $5.8 million (primarily capital spending), and financing provided $20.2 million, including $10.6 million of excess stock-compensation tax benefits and $10.2 million from option exercises and the employee stock purchase plan. Working-capital movements included higher receivables and inventory, partly offset by a $26.4 million increase in deferred revenue.
Material changes and management commentary
- Product revenue growth reflected higher switch and accessory sales, primarily to existing customers. Switch-port shipments rose 56.1%, while average selling price declined 4.0%.
- Service revenue grew with new and renewed support contracts and the larger installed base.
- Gross margin fell 3.6 percentage points, attributed to product and customer mix and a $2.2 million supplier settlement that benefited Q1 2014.
- Operating expenses rose 38.2% to $82.0 million, slower than revenue growth; R&D increased 29.6%, sales and marketing 31.8%, and G&A 94.6%. G&A growth primarily reflected $6.7 million of additional litigation expense related mainly to Cisco and OptumSoft.
- Management expects continued investment in R&D, sales and marketing, and infrastructure; it cautioned that operating profit as a percentage of revenue could decline in the short to medium term. The filing provides no numerical revenue or earnings guidance.
- Revenue mix shifted internationally: EMEA accounted for 22.4% of revenue versus 10.0% a year earlier; the Americas share was 70.8% versus 82.1%.
Risks, contingencies and unusual items
- Litigation: Cisco patent and copyright actions, including U.S. International Trade Commission investigations, seek unspecified damages and potential injunctions or exclusion orders affecting accused products. OptumSoft disputes ownership and use rights involving certain EOS software components. Arista said it could not determine whether a loss was probable or estimate a possible loss range in either matter; adverse outcomes could impair product sales, require royalties or damages, or result in injunctive relief.
- Internal controls: Management concluded disclosure controls were not effective as of March 31, 2015 because of a material weakness in review controls over cash-flow statement calculations and disclosures. A 2014 error involving duplicate recognition of excess tax benefits understated operating cash flow and overstated financing cash flow by $17.4 million; the filing says the error was corrected. Remediation was in progress and not complete.
- Supply-chain concentration: Two suppliers provided essentially all electronic manufacturing services, and key components include limited- and sole-source items. The company has no guaranteed supply contracts with component suppliers.
- Customer and operating variability: Large, concentrated orders, customer acceptance terms, pricing discounts, competition and quarterly purchasing patterns may create revenue and margin volatility. Inventory increased to $91.2 million from $80.5 million at year-end; finished goods included $11.3 million of deferred cost of revenue.
- Tax and other exposures: Gross unrecognized tax benefits were $21.3 million. Approximately $100.7 million of cash and securities was held abroad; repatriation could trigger U.S. taxes. The company also held $33.6 million of cost-method investments in private companies, which it described as inherently risky.
Key facts for investors to verify
- Whether the internal-control remediation is completed and whether subsequent cash-flow reporting is reliable.
- Developments, potential remedies and any estimated financial exposure in the Cisco and OptumSoft matters.
- Whether revenue growth continues and whether product/customer mix, pricing and the end of the prior-year supplier-settlement benefit affect gross margin.
- Customer concentration, order timing, product acceptance and the ability to convert deferred revenue into recognized revenue and cash collections.
- Component availability, reliance on contract manufacturers and inventory levels, including deferred product costs.
- Cash generation and the effect of stock-based compensation tax benefits, foreign cash and uncertain tax positions on reported cash flow and liquidity.