Arista Networks, Inc. — FY2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. This is an annual report, not a standalone Q4 filing; quarterly figures below are unaudited. Amounts are in U.S. dollars.
Business context
Arista sells Ethernet switching and routing platforms, its EOS network operating system, network applications, and related support services. Its markets include cloud and enterprise data centers, campus networks, and cloud-managed wireless. The business uses third-party manufacturers and depends on a limited number of suppliers for key components. Microsoft and Facebook each accounted for more than 10% of FY2019 revenue.
Key financial metrics
| Metric | FY2019 | FY2018 |
|---|---|---|
| Revenue | $2.411 billion | $2.151 billion |
| Product revenue | $2.021 billion | $1.841 billion |
| Service revenue | $389.6 million | $310.3 million |
| Gross profit / margin | $1.544 billion / 64.1% | $1.373 billion / 63.8% |
| Operating income | $805.8 million | $273.3 million |
| Net income | $859.9 million | $328.1 million |
| Diluted EPS | $10.63 | $4.06 |
| Cash from operations | $963.0 million | $503.1 million |
| Cash, cash equivalents and marketable securities, at year-end | $2.724 billion | $1.956 billion |
| Working capital, at year-end | $2.875 billion | $2.108 billion |
| Total indebtedness, at year-end | None reported | $37.7 million |
FY2019 operating cash flow increased substantially; investing activities used $284.1 million and financing activities used $218.0 million, primarily reflecting $266.1 million of share repurchases. Current assets were $3.472 billion and current liabilities were $597.1 million at year-end. The company reported $417.7 million of contractual obligations, including $279.2 million of purchase commitments due within one year.
Q4 FY2019: Revenue was $552.5 million, gross profit $356.3 million (about 64.5% margin), operating income $176.0 million, and net income $260.7 million. Revenue was down from $595.7 million in Q4 FY2018. Q4 net income included a $73.5 million income tax benefit.
Material changes versus comparable periods
- Annual revenue grew 12.1%, compared with 30.7% growth in FY2018. Product revenue rose 9.8%; service revenue grew 25.6%, lifting services to 16.2% of revenue from 14.4%.
- Gross margin edged up to 64.1% from 63.8%. Management cited favorable customer mix, partly offset by product transition and excess/obsolete inventory costs. Inventory write-downs were $41.2 million in FY2019 versus $20.8 million in FY2018.
- Operating income and net income rose sharply in part because FY2018 included a $405.0 million Cisco legal-settlement expense. FY2019 results also benefited from higher interest income and a net gain on private-company investments, versus a loss in FY2018.
- FY2019 income tax expense was only $2.4 million, a 0.3% effective rate, versus a $39.3 million tax benefit in FY2018. FY2019 included tax effects of an intra-entity transfer of non-Americas intellectual property; the unusually low rate should not be assumed to recur.
- Cash from operations rose to $963.0 million. Cash, cash equivalents and marketable securities increased by $768.2 million year over year. The company repurchased $266.1 million of shares under a $1.0 billion authorization, leaving about $733.9 million available at year-end.
Outlook, risks and unusual items
- The filing gives no quantified FY2020 revenue or earnings guidance. Management said Microsoft and Facebook purchases benefited from factors not expected to repeat in FY2020, and their combined share of revenue was expected to decline, likely weighing on revenue growth. Demand from some large customers had already been reduced and volatile.
- Arista expected cash and investments plus operating cash flow to meet working-capital and growth needs for at least the next 12 months. It planned continued investment in R&D, sales, and expansion into campus and WiFi markets.
- Management disclosed delayed production ramp-up of 400G products, citing limited optical-component availability. Risks also include customer concentration, competition and pricing pressure, dependence on contract manufacturers and sole- or limited-source components, inventory obsolescence, tariffs and geopolitical or public-health disruptions.
- On December 31, 2019, the company transferred non-Americas economic and beneficial IP rights within the company in exchange for a $3.4 billion non-interest-bearing note. The transaction generated significant deferred tax accounting effects and was a critical audit matter.
- OptumSoft litigation was settled in December 2019. A GlobalFoundries patent action filed in 2019 accused semiconductor devices used in Arista products; the filing reports that GlobalFoundries and TSMC settled their dispute, but does not state a resolution of Arista’s exposure. Management said other recorded litigation provisions were not significant and did not consider unresolved matters likely to have a material effect, while noting litigation uncertainty.
- Arista completed its acquisition of Big Switch Networks on February 5, 2020, after year-end, using existing cash. FY2019 financial statements do not include the acquisition.
- The auditor gave an unqualified opinion on the financial statements and internal controls; management and the auditor concluded internal control over financial reporting was effective at year-end.
Important facts for investors to verify
- How Microsoft and Facebook spending, customer concentration, and large-customer order timing affect FY2020 growth and margins.
- Whether 400G component supply and product ramp delays are resolved, and whether inventory write-downs or supplier liabilities increase.
- The sustainability of the 64.1% gross margin and the unusually low FY2019 effective tax rate, including the accounting and tax assumptions for the IP transfer.
- The final financial and legal effects of the GlobalFoundries matter, the Big Switch acquisition, and other contingencies.
- Whether operating cash generation remains strong after working-capital changes, continued investment, and share repurchases; also review the $279.2 million of near-term purchase commitments.