Arista Networks, Inc. — Q3 2023 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2023; comparisons are with the corresponding 2022 periods. Arista supplies cloud networking solutions, including EOS software, networking applications, and Ethernet switching and routing platforms. Results are unaudited.
Financial performance
| Metric | Q3 2023 | Q3 2022 | First 9 months 2023 | First 9 months 2022 |
|---|---|---|---|---|
| Revenue | $1.509B | $1.177B | $4.320B | $3.106B |
| Gross profit | $942.4M | $710.0M | $2.631B | $1.907B |
| Gross margin | 62.4% | 60.3% | 60.9% | 61.4% |
| Operating income | $602.7M | $417.3M | $1.617B | $1.058B |
| Net income | $545.3M | $354.0M | $1.474B | $925.4M |
| Diluted EPS | $1.72 | $1.13 | $4.66 | $2.92 |
- Q3 revenue rose 28.3% year over year; nine-month revenue rose 39.1%. Product revenue grew 27.4% and 42.0%, respectively, while service revenue grew 33.2% and 23.4%.
- Q3 gross margin improved year over year, but the nine-month margin was lower. Management attributed the changes primarily to product/customer mix and excess and obsolete inventory charges.
- Operating expenses were $339.7M in Q3, up 16.1%, and $1.014B for the nine months, up 19.4%. R&D and sales and marketing increases were primarily associated with headcount growth; nine-month R&D also reflected higher product-introduction costs.
- Other income was $41.8M in Q3 and $110.3M for the nine months, up from $6.8M and $37.8M. Higher interest income, principally from higher interest rates, was the main driver. The effective tax rate was 15.4% for Q3 and 14.7% year to date, down from 16.5% and 15.6%, primarily due to stock-based compensation tax benefits.
Cash flow, balance sheet, and liquidity
- Nine-month operating cash flow was $1.508B, compared with $452.3M in 2022. Cash flow benefited from earnings, tax-payment timing, collections, and higher deferred revenue; the $603.8M inventory increase and $118.6M increase in prepaid and other assets were significant offsets.
- At September 30, cash and cash equivalents were $1.749B and marketable securities were $2.707B, totaling approximately $4.5B. Current assets were $7.655B and current liabilities $1.847B. The balance sheet reports no borrowings or debt line item.
- Inventory increased to $1.894B from $1.290B at year-end 2022. Deferred revenue totaled $1.195B, compared with $1.041B at year-end.
- Management said available cash, cash equivalents, marketable securities, and operating cash generation should meet working-capital and growth needs for at least the next 12 months.
- Nine-month investing cash flow was a $350.5M outflow, largely reflecting purchases of marketable securities; financing cash flow was an $82.4M outflow, including $112.3M of share repurchases. No shares were repurchased in Q3.
Outlook, risks, and unusual items
- The filing provides no specific forward revenue or earnings guidance. Management expects some shipments against previously committed customer deployment plans to extend into 2024. It cautions that near-term revenue may benefit from those plans and may not reflect underlying demand.
- As lead times shorten, customer demand-planning horizons and visibility are also shortening, and management reports lower demand levels. Inventory and working capital may remain elevated near term; supplier purchase commitments are expected to decline as lead times shorten.
- Inventory exposure is material: non-cancellable purchase commitments were $2.0B, including $1.7B expected within 12 months, and inventory was $1.894B. The company warns of possible excess or obsolete inventory charges if demand falls short of forecasts.
- Management cites macroeconomic and geopolitical uncertainty, supply-chain and manufacturing constraints, inflationary cost pressure, customer spending changes, and customer technology-roadmap shifts, including investment in AI, as risks to demand, margins, and execution. Large-customer concentration and order timing can make results volatile.
- Remaining performance obligations were $2.1B, including $507.1M of binding agreements primarily for future product shipments. The filing expects the $507.1M to be recognized over two years; of the remaining $1.6B, approximately 76% is expected over the next two years and 24% in years three through five.
- On October 16, 2023, after quarter-end, the company paid the IRS $352.0M in estimated taxes following a payment-date extension. Management estimated an approximately $200M incremental 2023 cash-tax impact from required R&D capitalization under IRC Section 174.
- In the WSOU patent case, the PTAB ruled challenged claims unpatentable in May 2023; the district court case remained stayed pending appeal or final resolution. The company said a loss was reasonably possible but that any loss or range could not be estimated.
Key facts for investors to verify
- Whether improving shipment capacity and committed deployments offset shorter customer planning horizons and lower demand in subsequent quarters.
- How quickly inventory and the $2.0B purchase commitment balance decline, and whether excess/obsolete inventory charges affect margins or cash flow.
- Whether Q3 gross-margin improvement persists; year-to-date margin remained below the prior-year period.
- Customer concentration, order timing, pricing concessions, and the pace of enterprise and campus-market growth.
- Developments in the WSOU litigation and any change in the ability to estimate potential exposure.