Business context and reporting period
Arista Networks, Inc. supplies cloud networking solutions, including its EOS software and switching and routing platforms. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods. The company reports one operating segment.
Key financial metrics
Amounts below are in millions, except per-share data and percentages.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $519.8 | $405.2 | $992.3 | $740.7 |
| Gross profit | $333.9 | $259.8 | $636.8 | $474.0 |
| Gross margin | 64.2% | 64.1% | 64.2% | 64.0% |
| Operating income (loss) | $(239.8) | $116.6 | $(101.1) | $190.1 |
| Net income (loss) | $(155.3) | $102.7 | $(10.7) | $185.6 |
| Diluted EPS | $(2.08) | $1.30 | $(0.14) | $2.37 |
- Q2 revenue grew 28.3% year over year; first-half revenue grew 34.0%. Product revenue rose 25.7% and 32.1%, respectively; service revenue rose 46.3% and 46.7%.
- The operating and net losses principally reflect a $405 million legal settlement charge recorded in Q2. Excluding that charge, reported operating expenses and earnings would look materially different; the filing does not provide a formal non-GAAP reconciliation for that adjustment.
- Research and development expense rose 28.2% in Q2 and 26.8% for the half, primarily on personnel and engineering costs. Sales and marketing expense also increased; general and administrative expense declined.
- Cash provided by operations was $326.1 million for the first half, versus $242.1 million in 2017. The 2018 amount includes the $405 million accrued legal-settlement liability and therefore benefited from a substantial noncash working-capital item. Investing activities used $497.0 million, mainly for purchases of marketable securities; financing activities provided $23.4 million.
- At June 30, cash and cash equivalents were $711.2 million and marketable securities were $1.149 billion, or about $1.86 billion combined. Total current assets were $2.621 billion and current liabilities $826.8 million, including the $405 million settlement accrual. Management said liquidity and operating cash generation should meet working-capital and growth needs for at least 12 months.
- No conventional borrowings are listed in the balance sheet; lease financing obligations were $36.6 million noncurrent. Total liabilities were $1.112 billion.
Material changes versus the prior comparable period
- Revenue accelerated across products and services, supported by expansion among existing customers and market acceptance of newer switches. Americas remained the largest region; EMEA grew notably in the first half.
- Gross margin remained essentially stable at approximately 64%. Management cited scale benefits, partly offset by product-mix pressure and pricing competition.
- The $405 million Cisco settlement charge drove Q2 and first-half operating losses, compared with operating profits in 2017. First-half net loss was much smaller than the Q2 loss, reflecting first-quarter profitability.
- Marketable securities increased to $1.149 billion from $676.4 million at year-end, while cash and equivalents declined to $711.2 million from $859.2 million, largely reflecting securities purchases.
- Inventory fell to $245.4 million from $306.2 million at year-end. Deferred revenue was $448.6 million, down from the reported year-end balance, with the comparison affected by ASC 606 reclassifications and customer acceptance of redesigned products.
Outlook, commentary, risks and unusual items
- No specific numerical revenue, earnings, or margin guidance is provided. Management expects revenue to continue growing year over year in absolute dollars, while growth rates are expected to decline as the business scales. It expects operating expenses to rise in the near term and gross margins to fluctuate.
- Management attributes growth to existing-customer expansion, newer product acceptance, and a larger installed base supporting service revenue. It also cites ongoing product and service pricing pressure.
- On August 6, 2018, after quarter-end, Arista entered a binding term sheet with Cisco for a $400 million payment, mutual releases, a five-year stand-down on specified existing-feature patent claims, a three-year process for disputes over new or modified features, and certain CLI modifications. The company recorded a $405 million Q2 charge, including legal fees, and accrued that amount at June 30; the filing says payment was due by August 20. Final documentation and litigation dismissals remained pending.
- Other material legal exposure includes OptumSoft litigation over EOS-related software and trade-secret claims; Arista said loss was not probable, but a possible loss range could not be estimated. Cisco-related USITC proceedings and product redesigns also presented potential import, penalty, shipment, and customer-qualification risks pending settlement implementation.
- On August 2, 2018, Arista completed its acquisition of Mojo Networks, a Cognitive WiFi and cloud-managed wireless networking provider, funded from existing cash. The acquisition will be reflected beginning in Q3; financial effects are not quantified here.
- Other risks include large-customer concentration and uneven order timing, supply-chain and component availability, competition and pricing, product qualification and acceptance, and tax-law uncertainty. The company noted its Tax Act accounting remained under evaluation. New operating leases signed in the first half created approximately $46.4 million in future minimum commitments; non-cancellable purchase commitments totaled $269.6 million.
- Arista adopted ASC 606 on January 1, 2018 using the modified retrospective method. The filing says the effect on 2018 results was not material; the adoption included a $3.5 million increase to opening retained earnings.
Important facts for investors to verify
- Whether the Cisco term sheet was finalized, the $400 million payment was made as stated, and the pending district-court and USITC matters were dismissed or terminated as contemplated.
- How much of reported operating cash flow reflected settlement accruals, and the cash and liquidity position after the settlement payment and Mojo acquisition.
- Customer concentration, order timing, deferred-revenue movements, and acceptance of redesigned products, all of which can affect quarterly revenue recognition.
- Developments in the OptumSoft case and any resulting effect on EOS intellectual property, operations, or financial exposure.
- The financial contribution, integration costs, and cash impact of Mojo Networks, which are not quantified in this filing.