Arista Networks, Inc. — FY 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014. The filing is an annual report, not a standalone quarterly filing; fourth-quarter figures below are unaudited quarterly results included in the 10-K. Arista sells cloud-networking switches, EOS software and support services. Revenue is primarily from switch products.
Financial performance
| Metric | FY 2014 | FY 2013 |
|---|---|---|
| Revenue | $584.1 million | $361.2 million |
| Gross profit / margin | $392.1 million / 67.1% | $238.5 million / 66.0% |
| Operating income / margin | $125.5 million / 21.5% | $66.1 million / 18.2% |
| Net income / margin | $86.9 million / 14.9% | $42.5 million / 11.6% |
| Diluted EPS | $1.29 | $0.72 |
| Cash from operations | $114.5 million | $34.6 million |
- FY revenue grew 61.7%; switch-port shipments increased 82.4%, partly offset by a 15.0% decline in average selling price per port.
- Research and development expense was $148.9 million (25.5% of revenue); total operating expenses were $266.6 million, or 45.6% of revenue.
- At year-end, cash and cash equivalents were $240.0 million and marketable securities were $209.4 million. Working capital was $535.1 million; total assets were $811.0 million and stockholders’ equity was $555.7 million.
- Year-end lease financing obligations were $43.6 million. Convertible notes were largely converted to equity in the IPO; one noteholder was repaid. Contractual operating and financing lease payments totaled $100.2 million, including interest and land lease amounts for the financing obligation.
- FY 2014 investing cash outflow was $249.4 million, including $210.0 million of marketable-security purchases and $33.6 million of private-company equity investments. Financing cash inflow was $261.3 million, principally reflecting IPO proceeds.
Fourth-quarter results and period comparisons
- Q4 2014 revenue was $173.5 million, versus $114.8 million in Q4 2013, an increase of approximately 51%.
- Q4 2014 gross margin was 67.1%, operating income was $39.0 million (22.4% margin), and net income was $31.0 million (17.8% margin). Q4 2013 net income was $13.7 million.
- For the full year, gross margin improved from 66.0% to 67.1%. Management attributed the improvement mainly to $10.3 million less in warranty and excess/obsolete inventory-related charges than in 2013; higher manufacturing overhead and large-customer discounts partly offset the benefit.
- Microsoft, through channel partner World Wide Technology, represented 14.9% of FY 2014 revenue, down from 21.9% in 2013. The company’s ten largest customers made substantially greater additional purchases than initial purchases, but the filing emphasizes variability in large-order timing.
Outlook, risks and unusual items
- Management described cloud networking as an early-stage growth market and intends to continue investing in R&D, sales, international channels and operating infrastructure. It warned that operating profit as a percentage of revenue could decline in the short to medium term. The filing provides no specific numerical revenue or earnings guidance.
- Customer concentration and purchase timing are material risks: sales are generally purchase-order based, orders can be delayed or canceled, and Microsoft alone contributed 14.9% of FY 2014 revenue.
- Arista depends on two contract manufacturers and limited or sole-source component suppliers, without guaranteed supply contracts. Forecasting errors, shortages, excess inventory, price pressure and product quality issues could affect shipments and margins.
- Cisco filed patent and copyright lawsuits and two U.S. International Trade Commission complaints in December 2014. Cisco sought damages and injunctive relief, including possible exclusion of accused products from U.S. imports. Arista denied the allegations; management said loss was not considered probable and could not estimate a possible loss.
- OptumSoft litigation disputes ownership and use rights concerning certain EOS components. Arista intended to defend the case; management said it could not estimate a possible loss. A separate Net Navigation patent dispute was settled in June 2014.
- FY 2014 included a $4.0 million gain on notes receivable, following a repayment at twice the outstanding principal plus accrued interest. The filing also reports $33.6 million of private-company investments, described as inherently risky.
- The company completed its June 2014 IPO, receiving approximately $239.1 million net proceeds. A material weakness in inventory-related internal controls identified in the prior-year audit was reported as remediated in 2014; the external auditor did not audit internal-control effectiveness.
Important facts for investors to verify
- Whether revenue growth and customer expansion can continue while average selling prices decline and large-customer purchasing remains uneven.
- Whether reported margin improvement is sustainable, given the nonrecurrence of prior-year warranty and inventory charges and continued price, mix and manufacturing-cost pressures.
- The status and potential business impact of Cisco and OptumSoft disputes, including any injunction, product exclusion, royalty, damages or customer response.
- Cash-flow quality and liquidity, including working-capital movements, the availability and location of cash, and obligations under leases and uncertain tax positions.
- Whether supply-chain concentration, inventory exposure, product quality and the remediated financial-control processes remain adequately managed.