You should read the following discussion and analysis of our financial condition
and results of operations together with the unaudited condensed consolidated
financial statements and related notes that are included elsewhere in this
Quarterly Report on Form 10-Q, and our Annual Report on Form 10-K filed with the
SEC on February 14, 2020. This discussion contains forward-looking statements
based upon current plans, expectations and beliefs that involve risks and
uncertainties. Our actual results may differ materially from those anticipated
in these forward-looking statements as a result of various factors, including
those set forth under "Risk Factors" and elsewhere in this Quarterly Report on
Form 10-Q.
Overview
Arista Networks pioneered software-driven, cognitive cloud networking for
large-scale data center and campus environments. Our cloud networking solutions
consist of our EOS, a set of network applications and our Ethernet switching and
routing platforms. Our cloud networking solutions deliver industry-leading
performance, scalability, availability, programmability, automation and
visibility. At the core of our cloud networking platform is EOS, which was
purpose-built to be fully programmable, highly modular and reliable. The
programmability of EOS has allowed us to create a set of software applications
that address the requirements of cloud networking, including workflow
automation, network visibility and analytics, and has also allowed us to rapidly
integrate with a wide range of third-party applications for virtualization,
management, automation, orchestration and network services.
We believe that cloud networking will continue to replace legacy network
technologies across data center and campus environments. Our cloud networking
platforms are well positioned to address the growing cloud networking market,
and to address increasing performance requirements driven by the growing number
of connected devices, as well as the need for constant connectivity and access
to data and applications.
We generate revenue primarily from sales of our switching and routing products
which incorporate our EOS software. We generate the majority of our services
revenue from post contract support, or PCS, which end customers typically
purchase in conjunction with our products. Our end customers span a range of
industries and include large internet companies, service providers, financial
services organizations, government agencies, media and entertainment companies
and others. As we have grown the

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functionality of our EOS software, expanded the range of our product portfolio
and increased the size of our sales force, our revenue has grown rapidly. We
have also been profitable and operating cash flow positive for each year since
2010.
We believe our future success is dependent upon our ability to continue to
develop market leading products and features that address the needs of our end
customers and our ability to sell these products to new and existing customers,
including an increase in sales in the enterprise data center switching, campus
and WiFi networking markets. We intend to continue to invest in our sales
activities in key geographies, as well as our relationships with channel,
technology and system-level partners in order to reach new end customers more
effectively, increase sales to existing customers, and provide services and
support. In addition, we intend to continue to invest in our research and
development organization to enhance the functionality of our existing cloud
networking platform, introduce new products and features, and build upon our
technology leadership. We believe one of our greatest strengths lies in our
rapid development of new features and applications.
Our development model is focused on the development of new products based on our
EOS software and enhancements to EOS. We engineer our products to be agnostic to
the underlying merchant silicon architecture. Today, we combine our EOS software
with merchant silicon into a family of switching and routing products. This
enables us to focus our research and development resources on our software core
competencies and to leverage the investments made by merchant silicon vendors to
achieve cost-effective solutions. We work closely with third party contract
manufacturers to manufacture our products. Our contract manufacturers deliver
our products to our third party direct fulfillment facilities.  We and our
fulfillment partners then perform labeling, final configuration, quality
assurance testing and shipment to our customers.
Historically, large purchases by a relatively limited number of end customers
have accounted for a significant portion of our revenue. We have experienced
unpredictability in the timing of orders from these large end customers
primarily due to changes in demand patterns specific to these customers, the
time it takes these end customers to evaluate, test, qualify and accept our
products, and the overall complexity of these large orders. We expect continued
variability in our customer concentration and timing of sales on a quarterly and
annual basis. For example, our sales to Microsoft and Facebook as end users in
fiscal 2019 represented 23% and 17% of our revenue, respectively, and benefited
from certain factors that are not expected to repeat in fiscal 2020.
Consequently, the percentage of our revenue from Microsoft and Facebook in
fiscal 2020 is expected to decline, which will likely negatively impact our
revenue growth. In addition, we have provided, and may in the future provide,
pricing discounts to large end customers, which may result in lower margins for
the period in which such sales occur.
Recent Developments
In December 2019, a novel strain of coronavirus ("COVID-19") was identified in
Wuhan, China. This virus has spread globally, including to the United States. In
March 2020, the World Health Organization declared COVID-19 a pandemic.
Consequently, in an effort to contain COVID-19 or slow its spread, governments
around the world have issued orders to isolate residents to their homes,
practice social distancing when engaging in activities deemed "essential", close
all business deemed not essential, and place restrictions on travel and mass
gatherings. COVID-19 has negatively impacted the global economy, disrupted
business, sales activities, supply chains and workforce participation, including
our own, and created significant volatility and disruption of financial markets,
and we expect that the global health crisis caused by COVID-19 will continue to
negatively impact business activity for the foreseeable future.
We have taken numerous steps, and will continue to take further actions, in our
approach to address COVID-19. As a result, we have closed our offices across the
globe (including our corporate headquarters) limiting access to only those
employees providing essential activities, have instructed employees to work from
home, and have implemented travel restrictions. We have also worked closely with
our contract manufacturers and supply chain who have experienced delays in
component sourcing, and production and export of their products, which
negatively impacted our ability to supply products to our customers on a timely
basis during the three months ended March 31, 2020.
The extent of the impact of COVID-19 on our operational and financial
performance, including our ability to execute our business strategies and
initiatives in the expected time frame, will depend on future developments,
including the duration and spread of the pandemic, restrictions on travel,
transportation and other containment measures, our compliance with these
measures and the impact on our customers, partners, contract manufacturers and
supply chain, all of which are uncertain and cannot be predicted. However, any
continued disruption in manufacturing and supply resulting from the COVID-19
pandemic or resulting restrictions would negatively impact our business.  We
also expect that COVID-19 related disruptions may have a negative impact on
demand from our customers in future periods.  While we expect to see some
short-term strength in demand from our cloud titan customers, this may be more
than offset by prolonged sales cycles with new prospects in the campus and
enterprise markets, which could result in a year-over-year decline in revenues
in the second quarter of 2020 and this may also continue into the third quarter
or beyond. Accordingly, current results and financial condition discussed herein
may not be indicative of future operating results and trends.
In anticipation of further COVID-19 related disruptions to our business, we have
undertaken a comprehensive review of our investment and spending plans and
expect to reduce discretionary spending in future periods while maintaining an
ongoing

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focus on key initiatives. Although management is actively monitoring the impact
of COVID-19 on the Company's financial condition, liquidity, operations,
suppliers, industry, and workforce, the full impact of the pandemic continues to
evolve as of the date of this report. As such, the Company is unable to estimate
the effects of COVID-19 on its future results of operations, financial
condition, or liquidity.
Acquisition
On February 5, 2020, we acquired Big Switch Networks, Inc. ("Big Switch") a
network monitoring and software-defined networking pioneer headquartered in
Santa Clara, California. With the acquisition of Big Switch, we expect to expand
our data center networking solutions and further strengthen our network
monitoring and observability suite delivered through Arista's software platform
CloudVision and DANZ (DataANalyZer) capabilities.
Results of Operations
Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019
Revenue, Cost of Revenue and Gross Profit (in thousands, except percentages)
                                   Three Months Ended March 31,
                           2020          2019             Change in
                             $             $             $           %
Revenue
Product                 $ 410,906     $ 505,415     $ (94,509 )   (18.7 )%
Service                   112,123        90,009        22,114      24.6
Total revenue             523,029       595,424       (72,395 )   (12.2 )
Cost of revenue
Product                   163,629       198,152       (34,523 )   (17.4 )
Service                    21,149        16,702         4,447      26.6
Total cost of revenue     184,778       214,854       (30,076 )   (14.0 )
Gross profit            $ 338,251     $ 380,570     $ (42,319 )   (11.1 )%
Gross margin                 64.7 %        63.9 %


Revenue by Geography (in thousands, except percentages)


                                            Three Months Ended March 31,
                                    2020      % of Total       2019      % of Total
Americas                         $ 400,660         76.6 %   $ 439,638         73.8 %
Europe, Middle East and Africa      72,624         13.9       111,269         18.7
Asia-Pacific                        49,745          9.5        44,517          7.5
Total revenue                    $ 523,029        100.0 %   $ 595,424        100.0 %


Revenue

We generate revenue primarily from sales of our products. We also derive a portion of our revenue from sales of PCS, which is typically purchased in conjunction with our products, and subsequent renewals of those contracts. We expect our revenue may vary from period to period based on, among other things, the timing, size, and complexity of orders, especially with respect to our large end customers. Product revenue decreased $94.5 million, or 18.7%, for the three months ended March 31, 2020 compared to the same period in 2019. This decrease was primarily due to the recognition of $82.9 million of deferred revenue in the three months ended March 31, 2019 which related to shipments from prior periods for which customer acceptance was required. In addition, we experienced decreased demand from our existing customers in the current period, primarily driven by certain of our large end customers. Service revenue increased $22.1 million, or 24.6%, in three months ended March 31, 2020, compared to the same period in 2019 as a result of continued growth in initial and renewal support contracts as our customer installed base has continued to expand. International revenues represented 23.4% of total revenues in the three months ended March 31, 2020, down from 26.2% compared to the same period in the prior year, which was primarily due to a move toward U.S. deployments by certain of our large end customers. We continued to experience competitive pricing pressure on our products and services.




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Cost of Revenue and Gross Margin
Cost of revenue primarily consists of amounts paid for inventory to our
third-party contract manufacturers and merchant silicon vendors, overhead costs
in our manufacturing operations department, and other manufacturing-related
costs associated with manufacturing our products and managing our inventory.
Cost of providing PCS and other services primarily consists of personnel costs
for our global customer support organization.
Cost of revenue decreased $30.1 million, or 14.0% for the three months ended
March 31, 2020 compared to the same period in 2019, which was driven by a
corresponding decrease in revenue.
Gross margin, or gross profit as a percentage of revenue, has been and will
continue to be affected by a variety of factors, including sales to large end
customers who generally receive lower pricing, manufacturing-related costs
including costs associated with supply chain sourcing activities, merchant
silicon costs, the mix of products sold, and excess/obsolete inventory
write-downs, including charges for excess/obsolete component inventory held by
our contract manufacturers. We expect our gross margins to fluctuate over time,
depending on the factors described above.
Gross margin increased from 63.9% to 64.7% for the three months ended March 31,
2020 compared to the same period in 2019. The increase was primarily driven by a
decrease in product transition costs including some excess and obsolete
inventory-related charges, which was partially offset by a reduction in service
margins due to a relatively fixed services cost base on lower revenues.
Operating Expenses (in thousands, except percentages)
Our operating expenses consist of research and development, sales and marketing,
and general and administrative expenses. The largest component of our operating
expenses is personnel costs. Personnel costs consist of wages, benefits, bonuses
and, with respect to sales and marketing expenses, sales commissions. Personnel
costs also include stock-based compensation and travel expenses.
                                      Three Months Ended March 31,
                                2020         2019           Change in
                                 $            $            $           %
Operating expenses:
Research and development     $ 113,154    $ 119,669    $ (6,515 )   (5.4 )%
Sales and marketing             57,086       51,053       6,033     11.8
General and administrative      18,349       15,506       2,843     18.3
Total operating expenses     $ 188,589    $ 186,228    $  2,361      1.3  %


Research and development.
Research and development expenses consist primarily of personnel costs,
prototype expenses, third-party engineering and contractor support costs, and an
allocated portion of facility and IT costs including depreciation. Our research
and development efforts are focused on maintaining and developing additional
functionality for our existing products and on new product development,
including new releases and upgrades to our EOS software and applications. We
plan to continue to expand the capabilities of our cloud networking platform,
introduce new products and features and build upon our technology leadership.
However, in light of the COVID-19 outbreak, we plan to tightly manage our
spending in the coming year and as a result research and development expenses in
2020 may decrease from prior year levels.
Research and development expenses decreased $6.5 million, or 5.4%, in the three
months ended March 31, 2020 compared to the same period in 2019. The decrease in
the three months ended March 31, 2020 was primarily due to $14.3 million
decrease in new product introduction costs, including third party engineering
and other product development costs. This decrease was partially offset by $5.9
million in severance and other acquisition-related expenses from the Big Switch
acquisition, including facilities restructuring costs and retention bonuses, and
$2.8 million in stock-based compensation driven by refresh grants to existing
employees as well as grants to new employees acquired from Big Switch.
Sales and marketing.
Sales and marketing expenses consist primarily of personnel costs, marketing,
trade shows, and other promotional activities, and an allocated portion of
facility and IT costs, including depreciation. We intend to continue to
prudently manage our sales and marketing spend in 2020 with some targeted
investment in strategic sales activities and, accordingly, expect sales and
marketing expenses to remain relatively flat for the remainder of the year as
compared to 2019.
Sales and marketing expenses increased $6.0 million, or 11.8%, for the three
months ended March 31, 2020 compared to the same period in 2019. The increase in
the three months ended March 31, 2020 included $3.7 million in severance and
other

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acquisition-related expenses from the Big Switch acquisition, including
retention bonuses, and $2.8 million in personnel-related costs mostly driven by
an increase in headcount.
General and administrative.
General and administrative expenses consist primarily of personnel costs and
professional services fees. General and administrative personnel costs include
those for our executive, finance, human resources and legal functions. Our
professional services fees are primarily due to external legal, accounting and
tax services.
General and administrative expenses increased $2.8 million, or 18.3%, in the
three months ended March 31, 2020 compared to the same period in 2019. The
increase for the three months ended March 31, 2020 was primarily related to $2.2
million in severance and other acquisition-related expenses from the Big Switch
acquisition.
Other Income (Expense), Net (in thousands, except percentages)
Other income (expense) consists primarily of interest income from our cash, cash
equivalents and marketable securities, gains and losses on our investments in
privately-held companies, and foreign currency transaction gains and losses. We
expect other income (expense) may fluctuate in the future as a result of the
re-measurement of our private company equity investments upon the occurrence of
observable price changes and/or impairments, changes in interest rates or
returns on our cash and cash equivalents and marketable securities, and foreign
currency exchange rate fluctuations.
                                                     Three Months Ended March 31,
                                           2020           2019               Change in
                                            $              $               $             %
Other income (expense), net:
Interest income                        $   11,662     $   11,898     $      (236 )      (2.0 )%
Gain (loss) on investments in
privately-held companies                        -          1,150          (1,150 )    (100.0 )
Other income (expense), net                   495           (715 )         1,210      (169.2 )

Total other income (expense), net $ 12,157 $ 12,333 $ (176 ) (1.4 )%

The change in other income (expense), net, during the three months ended March 31, 2020 as compared to the same period in 2019 was primarily due to a favorable change in foreign currency gains and losses, which was largely offset by an unfavorable change in our investments in privately-held companies due to a gain recorded in the three months ended March 31, 2019. Provision for (Benefit from) Income Taxes (in thousands, except percentages) We operate in a number of tax jurisdictions and are subject to taxes in each country or jurisdiction in which we conduct business. Earnings from our non-U.S. activities are subject to local country income tax and may also be subject to U.S. income tax. Generally, our U.S. tax obligations are reduced by a credit for foreign income taxes paid on these foreign earnings which avoids double taxation. Our tax expense to date consists of federal, state and foreign current and deferred income taxes.


                                                       Three Months Ended March 31,
                                               2020          2019             Change in
                                                 $             $             $           %
Income before income taxes                  $ 161,819     $ 206,675     $ (44,856 )   (21.7 )%

Provision for (benefit from) income taxes 23,388 5,646 17,742 314.2 % Effective tax rate

                               14.5 %         2.7 %


For the three months ended March 31, 2020 and 2019, we recorded an expense of $23.4 million and $5.6 million for income taxes, respectively. Income taxes for the three months ended March 31, 2020 included lower tax benefits realized from tax settlements of stock-based compensation. The remaining changes in the income taxes were attributable to the overall decrease in worldwide earnings.





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Liquidity and Capital Resources
Our principal sources of liquidity are cash, cash equivalents, marketable
securities, and cash generated from operations. As of March 31, 2020, our total
balance of cash, cash equivalents and marketable securities was approximately
$2.6 billion, of which approximately $397.9 million was held outside the U.S. in
our foreign subsidiaries.
Our cash, cash equivalents and marketable securities are held for working
capital purposes. Our marketable securities investment portfolio is primarily
invested in highly rated securities with the primary objective of minimizing the
potential risk of principal loss. We plan to continue to invest for long-term
growth. We believe that our existing balances of cash, cash equivalents and
marketable securities together with cash generated from operations will be
sufficient to meet our working capital requirements and our growth strategies
for at least the next 12 months. Our future capital requirements will depend on
many factors, including our growth rate, the timing and extent of our spending
to support research and development activities, the timing and cost of
establishing additional sales and marketing capabilities, the introduction of
new and enhanced product and service offerings, our costs associated with supply
chain activities, including access to outsourced manufacturing, our costs
related to investing in or acquiring complementary or strategic businesses and
technologies, the continued market acceptance of our products, and stock
repurchases. If we require or elect to seek additional capital through debt or
equity financing in the future, we may not be able to raise capital on terms
acceptable to us or at all. If we are required and unable to raise additional
capital when desired, our business, operating results and financial condition
may be adversely affected.

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