Arista Networks, Inc. — Q1 2022 Form 10-Q
Reporting period: Three months ended March 31, 2022; comparisons are with the three months ended March 31, 2021 unless otherwise noted. Arista supplies cloud networking solutions, including its EOS software and Ethernet switching and routing platforms. Amounts below are in U.S. dollars; financial statement amounts are shown in millions unless stated otherwise.
Key financial metrics
| Metric | Q1 2022 | Q1 2021 | Change |
|---|---|---|---|
| Revenue | $877.1 | $667.6 | +31.4% |
| Product revenue | $724.7 | $539.1 | +34.4% |
| Service revenue | $152.3 | $128.4 | +18.6% |
| Gross profit / gross margin | $553.8 / 63.1% | $425.3 / 63.7% | +30.2% gross profit; margin down 0.6 percentage points |
| Operating expenses | $275.9 | $219.0 | +26.0% |
| Operating income / margin | $278.0 / 31.7% | $206.3 / 30.9% | +34.8% operating income |
| Net income | $272.3 | $180.4 | +51.0% |
| Diluted EPS | $0.85 | $0.57 | Prior-period per-share amounts reflect the November 2021 four-for-one stock split |
| Cash from operations | $217.1 | $254.7 | Down $37.5 |
| Capital expenditures | $14.9 | $5.1 | Free cash flow, calculated as operating cash flow less capital expenditures: $202.3 vs. $249.6 |
Balance sheet and liquidity
- At March 31, 2022, cash and cash equivalents were $635.0 million and marketable securities were $2,788.9 million, totaling about $3.424 billion. Approximately $600.1 million was held outside the United States.
- Total current assets were $5.105 billion and current liabilities were $1.369 billion. Total liabilities were $1.955 billion; the filing reports no debt balance.
- Accounts receivable was $648.6 million, inventories were $694.2 million, and current plus non-current deferred revenue was approximately $1.124 billion.
- Cash, cash equivalents and restricted cash increased $14.2 million during the quarter. The company said available liquidity and operating cash generation should meet working-capital needs and growth plans for at least 12 months.
Material changes and notable items
- Revenue growth reflected higher demand for switching and routing products across existing customers, new customer additions and continued growth in initial and renewal support contracts. Americas revenue rose to $664.4 million; EMEA was $134.8 million and Asia-Pacific was $77.9 million.
- Gross margin declined to 63.1%, primarily due to higher supply-chain costs; improved product margins from a lower proportion of sales to heavily discounted large customers partly offset the pressure. Management also cited competitive pricing pressure.
- Net income included $28.5 million of unrealized gains on equity investments, compared with none in Q1 2021. This included a $15.0 million valuation adjustment on private-company shares and gains associated with an investee’s public-market trading. The gain increased reported earnings and was not operating revenue.
- Operating cash flow was lower despite higher net income, reflecting working-capital outflows, including higher receivables, inventory and prepaid/current assets. Increased deferred revenue and income taxes payable partly offset those uses.
- In January, Arista acquired a privately held U.S. technology company for $47.0 million in cash and stock, recognizing $28.5 million of goodwill and $19.0 million of intangible assets.
- Arista repurchased 1.171 million shares for $136.2 million at an average $116.30 per share. About $790.8 million remained under its $1.0 billion repurchase authorization.
Outlook, risks and contingencies
- The filing provides no numerical revenue or earnings guidance. Management expects continued investment in research and development and sales and marketing, and warned that gross margins may fluctuate.
- Management described significant supply-chain constraints, component shortages, longer lead times, higher costs and inflationary pressure. These conditions could limit shipments, increase costs and reduce margins. The company extended its demand-planning horizon, increased inventory and purchase commitments, and expects further working-capital investment.
- Non-cancellable purchase commitments totaled $4.319 billion, including $2.428 billion with confirmed receipt dates within 12 months and $1.041 billion with receipt dates yet to be confirmed. The filing notes the risk that supplier delivery or actual customer demand may not match forecasts, potentially leading to excess or obsolete inventory.
- Beginning in 2022, IRC Section 174 requires research and development costs to be capitalized and amortized for tax purposes. Arista recorded an incremental tax liability of $49.0 million as of March 31 and said it may incur up to an additional $130.0 million in tax liabilities during the remainder of 2022.
- In the WSOU patent case, one patent was dismissed with prejudice on March 30, 2022; the remaining litigation was scheduled for trial in October 2023. The company said a loss was reasonably possible but that a loss range could not be estimated. It intends to defend the claims.
- Other key risks cited include customer concentration and ordering variability, competition, COVID-19-related disruption, the Russia-Ukraine conflict, inflation, geopolitical and trade risks, cybersecurity threats and changing tax rules.
Important facts for investors to verify
- Whether supply constraints, large purchase commitments and inventory growth translate into timely shipments and customer demand without excess or obsolete inventory.
- How much of earnings growth is supported by recurring operations versus the $28.5 million unrealized investment gain.
- Whether gross-margin pressure from supply costs and competitive pricing continues, and how customer and product mix affects margins.
- The timing and cash impact of the Section 174 tax requirement, including potential additional 2022 tax liabilities.
- Developments in the WSOU litigation and any material change in the estimated exposure.