Arista Networks, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; unaudited, prepared under U.S. GAAP. Arista supplies cloud networking solutions, including EOS software and switching and routing platforms.
Financial performance
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Revenue | $1,351.4 million | $877.1 million | +54.1% |
| Product revenue | $1,172.1 million | $724.7 million | +61.7% |
| Service revenue | $179.3 million | $152.3 million | +17.7% |
| Gross profit / margin | $804.5 million / 59.5% | $553.8 million / 63.1% | Margin down 3.6 percentage points |
| Operating expenses | $319.9 million | $275.9 million | +16.0% |
| Operating income | $484.6 million | $278.0 million | +74.3% |
| Net income | $436.5 million | $272.3 million | +60.3% |
| Diluted EPS | $1.38 | $0.85 | +$0.53 |
| Cash from operations | $374.5 million | $217.1 million | +$157.3 million |
Gross margin fell mainly because sales to large customers, who generally receive discounts, made up a greater share of revenue, and excess/obsolete inventory provisions increased. Higher material and logistics costs also weighed on margins; fixed-overhead leverage partially offset these pressures. Other income was $12.1 million, versus $31.5 million a year earlier: higher interest income was offset by a $5.6 million unrealized equity-investment loss, compared with a $28.5 million gain in Q1 2022. The effective tax rate was 12.1%, compared with 12.0%.
Cash, liquidity and balance sheet
- Cash and cash equivalents were $956.3 million; marketable securities were $2,374.8 million. Together, these totaled approximately $3.3 billion, including $426.7 million held outside the U.S.
- Operating cash flow was $374.5 million. Capital expenditures were $5.6 million, implying approximate free cash flow of $368.9 million (operating cash flow less property and equipment purchases).
- Cash, cash equivalents and restricted cash increased $284.6 million during the quarter. Investing activities used $21.7 million and financing activities used $68.4 million.
- Inventory rose to $1,682.7 million from $1,289.7 million at year-end 2022. Accounts payable and accrued liabilities also increased; management attributed working-capital demands in part to higher business volume and product lead times.
- Total liabilities were $2,213.9 million, including $1,584.9 million of current liabilities. The balance sheet reports no borrowings or debt; deferred revenue totaled $1,092.3 million.
- Non-cancellable purchase commitments were $2.9 billion, of which $2.4 billion had confirmed receipt dates within 12 months. Operating lease obligations were $81.2 million.
Material changes and business developments
- Product revenue growth reflected strong demand across the customer base, particularly from large cloud customers. Americas revenue increased to $1,115.0 million from $664.4 million; EMEA revenue declined to $128.3 million from $134.8 million, and Asia-Pacific revenue increased to $108.0 million from $77.9 million. The Americas represented 82.5% of revenue, up from 75.7%.
- Operating expenses grew more slowly than revenue, rising 16.0%. R&D increased 17.1%, primarily from personnel costs and new-product introduction costs.
- Stock repurchases were $82.3 million for 735,000 shares at an average $111.90 per share. Approximately $174.5 million remained under the $1.0 billion authorization, which expires in Q4 2024.
- Revenue recognized from the beginning deferred-revenue balance was $214.5 million. Total future revenue from contract liabilities, deferred revenue and other performance obligations was $2.2 billion, including $908.6 million in binding agreements primarily for future product shipments.
Outlook, risks and contingencies
- The filing provides no quantified revenue, margin or EPS guidance. Management said existing cash, cash equivalents, marketable securities and operating cash generation should meet working-capital needs and growth plans for at least the next 12 months.
- Management reported some improvement in sourcing and customer lead times, but warned that improved lead times may reduce demand visibility and shorten planning horizons. Inventory and working capital may remain elevated near term; excess or obsolete inventory charges remain possible. Management expects purchase commitments to decline as supplier lead times shorten.
- Inflation, component scarcity, logistics costs, manufacturing disruptions, geopolitical risks and uncertain customer spending may pressure margins, cash flow and demand. Large-customer concentration and customer cost-cutting initiatives create additional risk to order timing and forecasts.
- Arista estimated an approximately $190 million incremental 2023 cash-tax impact from the requirement to capitalize and amortize R&D costs under IRC Section 174; it reported no material resulting change to its effective tax rate.
- The WSOU patent case remained stayed pending inter partes review of one patent. Arista said a loss was reasonably possible but that any potential loss or range could not be estimated. Management stated that recorded provisions for other claims were not significant.
- Management said disclosure controls were effective at a reasonable-assurance level and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether strong large-cloud-customer demand continues, given customer concentration, spending cycles and limited visibility; Microsoft and Meta together accounted for 42% of 2022 revenue.
- Whether inventory and purchase commitments decline as lead times improve, and whether demand shortfalls trigger inventory write-downs or further cash-flow pressure.
- Whether gross margin recovers from 59.5%, considering customer mix, discounting, supply-chain costs and inventory provisions.
- How the $2.9 billion of non-cancellable purchase commitments and estimated $190 million 2023 incremental cash-tax impact affect liquidity and cash conversion.
- Developments in the WSOU litigation and any material change to the estimated exposure.