Arista Networks, Inc. — FY2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015. The filing also reports unaudited fourth-quarter results. Arista supplies cloud-networking switches and software, centered on its Extensible Operating System (EOS), to internet companies, cloud providers and enterprise data centers.
Financial performance and liquidity
| Metric | FY2015 | FY2014 | Change |
|---|---|---|---|
| Revenue | $837.6 million | $584.1 million | +43.4% |
| Gross profit / margin | $543.6 million / 64.9% | $392.1 million / 67.1% | Margin down 2.2 percentage points |
| Operating income / margin | $149.3 million / 17.9% | $125.5 million / 21.5% | Income +19.0%; margin down 3.6 points |
| Net income / diluted EPS | $121.1 million / $1.67 | $86.9 million / $1.29 | Net income +39.4% |
| Cash from operations | $200.5 million | $131.9 million | +52.1% |
- Product revenue was $744.9 million (+40.1%); service revenue was $92.7 million (+76.4%). Service grew to 11.1% of revenue from 9.0%.
- R&D expense was $209.4 million, sales and marketing $109.1 million, and general and administrative expense $75.7 million. G&A more than doubled, primarily due to $39.8 million of increased legal fees relating mainly to Cisco and OptumSoft matters.
- At year-end, cash and cash equivalents were $687.3 million, working capital $739.3 million, total assets $1.160 billion and stockholders’ equity $788.2 million. No marketable securities remained at year-end.
- Total indebtedness was $42.5 million, comprising the lease-financing obligation; the filing reports no outstanding notes payable at year-end. Contractual commitments included $52.1 million of operating leases and $43.9 million of non-cancelable purchase obligations.
- Net cash provided by investing activities was $184.2 million, mainly reflecting maturities of marketable securities. Financing activities provided $63.1 million. Cash increased $447.3 million during the year.
- Fourth-quarter revenue was $245.4 million and net income $43.9 million, compared with $173.5 million and $31.0 million, respectively, in Q4 2014.
Material changes versus the prior comparable period
- FY2015 revenue growth was strong but slower than FY2014’s 61.7% growth. The company reported more than 3,700 cumulative end customers and said it had shipped over five million switch ports.
- Gross margin declined to 64.9% from 67.1%, primarily due to inventory-obsolescence charges associated with product transitions, higher warranty costs and a greater mix of large customers receiving volume discounts. Inventory write-downs were $9.0 million, versus $2.8 million in 2014.
- Operating expenses rose 47.9%, faster than revenue. G&A growth was driven mainly by litigation-related legal costs; R&D and sales and marketing spending also increased to support product development and expansion.
- The effective tax rate fell to 17.1% from 28.5%, reflecting lower-tax foreign earnings, releases of certain tax reserves and the reinstated federal R&D credit.
- Microsoft, purchasing through channel partner World Wide Technology, accounted for 12.0% of FY2015 revenue, down from 14.9% in 2014. Revenue remains concentrated among large customers.
Outlook, risks and unusual items
- Management expects to continue investing in R&D, sales and marketing, and operating infrastructure. It cautioned 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.
- Management believes existing cash and operating cash flow will meet working-capital needs and growth plans for the foreseeable future. Approximately $41.6 million of cash was held outside the United States and was considered indefinitely reinvested; repatriation could trigger U.S. tax.
- Cisco litigation: Cisco alleges patent and copyright infringement and seeks damages and injunctive relief. On February 2, 2016, after fiscal year-end, an ITC administrative law judge issued an initial determination finding a Section 337 violation on certain patent claims in one investigation; Arista sought Commission review. A separate investigation remained pending. A final adverse outcome could restrict imports or sales, require design changes or royalties, and disrupt shipments. The company said loss was not probable, but reasonably possible, and that a loss range could not be estimated.
- OptumSoft dispute: A proposed Phase I decision issued in December 2015 supported Arista’s ownership of the software at issue in that phase. OptumSoft objected, and remaining issues were scheduled for trial in April 2016. Further adverse rulings could affect EOS-related intellectual property or product rights.
- Other notable exposures include customer and supplier concentration, reliance on a small number of contract manufacturers and key component suppliers, pricing competition, product quality and warranty costs, and risks from rapid growth. No long-term customer purchase commitments exist, and orders may be canceled or changed before shipment.
- The company recorded $45.3 million in stock-based compensation. Its FY2015 financial statements and internal-control effectiveness received unqualified audit opinions; management reported effective internal control after remediating a prior cash-flow review-control weakness.
Important facts for investors to verify
- Track the final outcomes and remedies in both Cisco ITC investigations and related court cases, including any effect on product imports, shipments, customer indemnities and legal expense.
- Monitor whether customer concentration, particularly Microsoft’s purchases, changes materially and whether large orders remain volatile.
- Assess whether gross margins recover as product transitions and inventory charges ease, and whether higher warranty costs persist.
- Compare ongoing R&D, sales and infrastructure investment with revenue growth, operating margins and cash generation.
- Review cash-flow quality, including the contribution from deferred revenue and other working-capital changes, as well as inventory, purchase commitments and supplier exposure.
- Check the progress of the OptumSoft litigation, tax uncertainties, and adoption of new accounting standards, including the forthcoming revenue-recognition standard.