Arista Networks, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020; filed August 4, 2020. Arista supplies cloud networking hardware and software, including EOS, switching and routing platforms, and support services. Comparisons below are year over year unless noted.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $540.6 million | $608.3 million | $1,063.6 million | $1,203.7 million |
| Product revenue | $421.4 million | $513.2 million | $832.3 million | $1,018.6 million |
| Service revenue | $119.2 million | $95.2 million | $231.3 million | $185.2 million |
| Gross profit / margin | $344.1 million / 63.7% | $390.2 million / 64.1% | $682.3 million / 64.2% | $770.8 million / 64.0% |
| Operating income / margin | $167.0 million / 30.9% | $206.8 million / 34.0% | $316.7 million / 29.8% | $401.2 million / 33.3% |
| Net income | $144.8 million | $189.3 million | $283.2 million | $390.3 million |
| Diluted EPS | $1.83 | $2.33 | $3.56 | $4.80 |
| Operating cash flow | Not separately presented quarterly | $333.1 million | $366.5 million |
- Q2 revenue fell 11.1%; product revenue declined 17.9%, while service revenue rose 25.2%. For the first half, revenue fell 11.6%, product revenue fell 18.3%, and service revenue grew 24.9%.
- Q2 gross margin eased 0.4 percentage points; first-half gross margin improved 0.2 points. Management attributed margin pressure in both periods to customer mix and larger-volume discounts; COVID-related supply costs were largely offset by lower product-transition costs.
- Operating expenses were $177.1 million in Q2, down 3.4%; first-half expenses were $365.7 million, down 1.1%. First-half R&D declined 4.0%, while sales and marketing rose 4.1%, partly reflecting Big Switch-related costs.
- Other income, net, was $8.3 million in Q2 and $20.4 million for the half, down 40.2% and 21.9%, respectively, mainly due to lower interest income; the prior-year half also included a private-investment gain. Effective tax rates were 17.4% and 16.0%, versus 14.2% and 8.7% in the comparable periods, primarily reflecting lower stock-compensation tax benefits.
Liquidity, cash flow and balance sheet
- At June 30, cash and cash equivalents were $800.2 million and marketable securities were $1,981.6 million, totaling approximately $2.8 billion. Approximately $428.9 million was held outside the U.S. Current assets were $3.58 billion and current liabilities $640.2 million.
- Cash, cash equivalents and restricted cash decreased $311.0 million in the first half. Operating activities provided $333.1 million; investing used $432.8 million, including $361.3 million net purchases of marketable securities and $66.3 million for the Big Switch acquisition; financing used $209.7 million, including $227.9 million of share repurchases.
- Inventory increased to $327.0 million from $243.8 million at year-end, as the company built working capital to mitigate supply-chain disruption. Deferred revenue totaled $577.5 million, up from $502.2 million a year earlier. About $687.7 million of remaining performance obligations was expected to be recognized, with 81% over the next two years.
- The balance sheet does not report borrowings or other conventional debt. Total liabilities were $1.30 billion, including lease liabilities and deferred revenue. Management said cash, securities and operating cash generation should cover working capital and growth plans for at least 12 months.
Material developments, outlook and risks
- Arista acquired Big Switch Networks on February 5, 2020, for $73.3 million cash, with $5.3 million of severance and other costs treated as post-combination expense. Purchase accounting was preliminary; the acquisition added $49.0 million of intangibles and $29.9 million of goodwill. It had no material reported impact on current-period revenue or net income.
- Management expected a year-over-year revenue decline for full-year 2020, citing COVID-19 disruption and the expected reduction in revenue contribution from Microsoft and Facebook, which together represented 40% of 2019 revenue and benefited from factors not expected to recur. No specific quarterly revenue or EPS guidance is provided in the supplied filing text.
- COVID-19 caused supplier and contract-manufacturer delays, constrained shipments, longer lead times and increased supply costs. Management noted some demand strength from cloud customers, but expected this could be offset by longer enterprise and campus sales cycles. The full impact on future results, liquidity and operations remained uncertain.
- Management planned to manage discretionary spending; R&D expense in 2020 could fall from prior-year levels, while sales and marketing expense was expected to remain relatively flat for the rest of the year. Lower interest rates were expected to reduce interest income in 2020.
- Other key risks include customer concentration and variable order timing, competitive pricing pressure, reliance on limited-source components and third-party manufacturers, inventory obsolescence, delayed 400G product ramps due to optical-component availability, and execution risks in campus and WiFi markets.
- Non-cancellable purchase commitments were $570.3 million at June 30, 2020. The company reported no significant recorded provisions for ordinary-course legal matters, but noted that litigation outcomes are inherently uncertain and could be material if unfavorable.
Important facts for investors to verify
- How persistent product-revenue weakness and COVID-related supply constraints are, and whether service growth can offset product declines.
- Actual full-year revenue performance against management’s stated expectation of a year-over-year decline, including the impact of large-customer concentration and 2019 comparison effects.
- Whether inventory build, $570.3 million in purchase commitments and longer lead times result in improved fulfillment or create excess and obsolete inventory exposure.
- Progress and costs of integrating Big Switch, and the timing of the 400G product ramp given optical-component availability.
- Cash generation, marketable-securities liquidity, repurchase activity and the company’s ability to fund commitments and growth without borrowing.