Arista Networks, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; unaudited. Arista supplies cloud networking solutions, including EOS software and Ethernet switching and routing products. Amounts below are in U.S. dollars; financial statement amounts are rounded to millions unless otherwise stated.
Financial performance and position
| Metric | Q1 2019 | Q1 2018 / prior balance date | Change |
|---|---|---|---|
| Revenue | $595.4 million | $472.5 million | Up 26.0% |
| Product revenue | $505.4 million | $407.6 million | Up 24.0% |
| Service revenue | $90.0 million | $64.9 million | Up 38.7% |
| Gross profit / margin | $380.6 million / 63.9% | $302.9 million / 64.1% | Margin down 0.2 percentage points |
| Operating income / margin | $194.3 million / 32.6% | $138.7 million / 29.4% | Operating income up 40.1% |
| Net income | $201.0 million | $144.5 million | Up 39.1% |
| Diluted EPS | $2.47 | $1.79 | Up 38.0% |
| Operating cash flow | $170.1 million | $195.5 million | Down $25.4 million |
| Cash, cash equivalents and marketable securities | $2.15 billion at March 31, 2019 | $1.96 billion at December 31, 2018 | Up approximately $190 million |
Operating cash flow was below net income, reflecting working-capital uses, particularly an $82.6 million inventory increase and a $50.8 million decrease in deferred revenue. Cash and cash equivalents were $809.5 million and marketable securities were $1.34 billion. Management said available liquidity and operating cash generation should meet working-capital needs and growth plans for at least the next 12 months.
Total assets were $3.33 billion and total liabilities were $932.1 million at quarter-end. The filing discloses no borrowings; operating lease liabilities totaled $107.8 million, including $14.1 million current and $93.6 million non-current. Non-cancellable purchase commitments were $253.8 million.
Changes and management commentary
- Revenue growth was driven mainly by existing customers expanding and upgrading cloud networks, acceptance of newer switch products, and growth in initial and renewed support contracts.
- Americas revenue rose to $439.6 million from $315.5 million; EMEA revenue fell to $111.3 million from $121.9 million; Asia-Pacific revenue increased to $44.5 million from $35.1 million.
- Gross margin edged down as product transition costs, including excess and obsolete inventory charges, were mostly offset by favorable customer mix. Service margins improved.
- Research and development expense rose 16.9% to $119.7 million, and sales and marketing expense rose 21.2% to $51.1 million, reflecting investment and headcount growth. General and administrative expense fell 21.2% to $15.5 million, primarily because Cisco litigation costs declined following its August 2018 settlement.
- Management expects revenue to grow year over year in absolute dollars but anticipates lower growth rates as the business scales. It reported a recent slowdown in demand from certain large customers that could continue. No specific quarterly or full-year revenue or earnings guidance is provided in the filing.
- Arista reported that Microsoft represented 27% of FY2018 revenue and expected its share of FY2019 revenue to decline. Large-customer order timing and discounts can cause substantial quarterly revenue and margin variability.
Risks, contingencies and unusual items
- OptumSoft litigation: Remaining contract, trade-secret and confidentiality issues were scheduled for a Phase II trial on the first date available after December 2, 2019. The company said loss was not probable but reasonably possible; any loss or range could not be estimated. An adverse ruling could affect ownership or use of EOS components and involve damages or injunctive relief.
- Supply, inventory and demand: The company relies on third-party manufacturers and a limited number of component suppliers. Inventory increased $82.6 million in the quarter, primarily for upcoming product transitions; excess inventory, component shortages, customer order delays and pricing pressure could affect revenue and margins.
- Customer concentration and competition: Large purchases by a limited number of customers, potential continued slowdown at certain large customers, competition and price pressure are key uncertainties. Management warned that quarterly results can fluctuate and that historical growth is not necessarily indicative of future performance.
- Leases: Adoption of ASC 842 on January 1, 2019 added operating lease assets and liabilities and resulted in a $3.7 million opening retained-earnings adjustment. The headquarters build-to-suit arrangement was reclassified from a finance lease to an operating lease.
- Tax and other income: The effective tax rate was 2.7%, versus a 1.2% benefit in Q1 2018. Other income included $11.9 million of interest income and a $1.2 million gain on a private-company investment.
- Capital return: After quarter-end, the board authorized a $1.0 billion share repurchase program, expiring in April 2022. The authorization is discretionary and does not obligate the company to repurchase shares.
- Other disclosed exposures include trade tariffs, foreign exchange and interest-rate movements, private-company investment risk, product defects, cybersecurity, and legal and intellectual-property claims.
Important facts for investors to verify
- Whether demand from large customers, including Microsoft, continued to slow and how customer concentration affected subsequent revenue and margins.
- Whether inventory associated with product transitions was converted to sales or led to further excess and obsolescence charges.
- Progress and potential exposure in the OptumSoft case, including developments toward the Phase II trial.
- Cash generation and liquidity after working-capital movements, purchase commitments, lease payments and any share repurchases.
- Whether reported revenue growth and gross-margin trends were sustained, given pricing pressure, product mix and management’s expectation of slower growth rates.