Arista Networks, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Unaudited results; amounts below are in millions of dollars except per-share data. Arista supplies cloud networking hardware, EOS software and related support.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $563.3 | $437.6 | $1,555.6 | $1,178.3 |
| Gross profit / margin | $361.6 / 64.2% | $280.6 / 64.1% | $998.4 / 64.2% | $754.6 / 64.0% |
| Operating income (loss) / margin | $180.8 / 32.1% | $140.8 / 32.2% | $79.7 / 5.1% | $330.9 / 28.1% |
| Net income | $168.5 | $133.7 | $157.8 | $319.4 |
| Diluted EPS | $2.08 | $1.68 | $1.95 | $4.06 |
| Cash from operating activities | — | $207.3 | $448.0 |
- Q3 revenue grew 28.7% year over year; product revenue rose 27.6% and service revenue 35.9%. Nine-month revenue increased 32.0%.
- Q3 operating income increased 28.4% year over year, while nine-month operating income and net income were sharply lower primarily because of the Cisco settlement charge.
- For the nine months, the company recorded a $405.0 million legal settlement charge in operating expenses and paid Cisco $400.0 million in August. The filing reports a related income tax benefit of $99.9 million for the nine-month period. The charge drove the reported nine-month operating margin down to 5.1%.
- Nine-month effective tax rate was negative 74.7%, reflecting the discrete tax benefit associated with the settlement, as well as other tax effects. Q3 effective tax rate was 11.0%.
Balance sheet, liquidity and cash flow
- At September 30, cash and cash equivalents were $524.7 million and marketable securities were $1,137.1 million, totaling about $1.66 billion. Cash, cash equivalents and restricted cash for cash-flow reporting totaled $528.9 million.
- Total current assets were $2.44 billion; current liabilities were $539.8 million. Total liabilities were $852.4 million and stockholders’ equity was $1.95 billion.
- The filing reports no conventional borrowing balance; it reports $36.0 million of non-current lease financing obligations. Management said available liquidity and operating cash flows should cover working capital and growth needs for at least 12 months.
- Nine-month operating cash flow fell to $207.3 million from $448.0 million. Investing activities used $583.5 million, including $827.2 million of marketable-security purchases, partly offset by maturities, and $95.6 million of acquisition cash outflow. Cash and restricted cash declined $335.8 million during the period.
- Deferred revenue was $529.9 million. Remaining performance obligations were approximately $555.2 million; the company expected to recognize about 84% over the next two years and the remainder in years three through five.
Material changes and management outlook
- Gross margin was broadly stable. Management attributed slight improvement to scale-related fixed-cost leverage, partly offset by lower product margins from customer mix. It expects margins to fluctuate with customer, product and geographic mix, pricing, component costs and inventory conditions.
- Management cited expansion by existing customers and acceptance of newer switches as revenue drivers. It expects revenue to continue increasing year over year in absolute dollars, but expects growth rates to decline as the business scales. No specific numerical revenue or earnings guidance is provided in the filing.
- Research and development expense rose 47.7% in Q3, reflecting hiring, acquisitions and increased new-product development costs. Management expects operating expenses to rise in absolute dollars in the near term as it invests in growth.
- Arista acquired Mojo Networks and Metamako in Q3 for total consideration of approximately $116.5 million, primarily to expand cognitive cloud networking and low-latency offerings. Acquired businesses’ revenue and earnings were immaterial during the reported periods.
- The company adopted ASC 606 in January 2018; management said the impact on 2018 financial results was not material. It expects the new lease accounting standard, planned for adoption in Q1 2019, to materially increase balance-sheet assets and liabilities, with no material income-statement impact expected.
Risks, contingencies and unusual items
- The Cisco settlement ended the parties’ ongoing district court and USITC litigation and included mutual releases, a five-year stand-down for certain patent claims, a three-year process for disputes involving new or modified features, and agreed CLI modifications. The company also noted customer requalification related to product feature changes could affect revenue timing and deferred revenue.
- OptumSoft litigation remains unresolved. Phase II was scheduled for September 2019; Arista said a possible loss was reasonably possible but could not estimate a loss or range. An adverse ruling could affect ownership or use of EOS-related intellectual property and could result in damages or injunctive relief.
- Supply-chain, component availability, contract-manufacturer capacity, large-customer order timing and pricing pressure could affect shipments, revenue and margins. The company reported $423.1 million of non-cancellable purchase commitments, without a related liability recorded.
- Management highlighted U.S.–China tariffs: a 10% tariff on a further category of Chinese imports, including communications equipment and components, took effect in September 2018 and was expected to rise to 25% in January 2019. Supply-chain changes may not fully offset cost or demand effects.
- Other risks include customer concentration and unpredictable large orders, competition, foreign-exchange exposure, tax-law uncertainty and valuation risk in private-company investments. The nine-month results include a $9.1 million net unrealized loss on private-company investments.
- The company reported disclosure controls and procedures were effective at a reasonable-assurance level as of September 30, 2018, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of reported growth reflects repeat customer expansion versus large, potentially variable orders, and how customer concentration has changed.
- The sustainability of margins and cash generation amid pricing pressure, higher R&D spending, tariff exposure and supply commitments.
- Integration progress and expected contribution from Mojo and Metamako, including acquisition-related costs and potential tax effects.
- Updates on the OptumSoft case and any consequences of Cisco-related product requalification or the ITC order-modification process.
- The filing gives differing acquisition share counts: the purchase-price note cites 58,072 shares, while the unregistered-sales disclosure cites 79,821 shares issued for Metamako; confirm the reconciliation in the underlying transaction disclosures.