ARISTA NETWORKS, INC. 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 theSEC onFebruary 15, 2022 . 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. OverviewArista Networks pioneered data-driven, cognitive cloud networking for large-scale data center and campus workspace environments. Our cloud networking solutions consist of our Extensible Operating System ("EOS"), a set of network applications and our Ethernet switching and routing platforms. We are a leader in cloud networking solutions delivering high performance, scalability, availability, programmability, workload orchestration, automation and visibility. In recent years, we have sought to bring the operational consistency and principles of cloud networking to the broader enterprise and campus markets with our Cognitive Cloud Networking, extending EOS across the enterprise data center and campus wired and wireless workspaces. We generate revenue primarily from sales of our switching and routing platforms, which incorporate our EOS software, and related network applications. We also generate revenue from post-contract support ("PCS"), which end customers typically purchase in conjunction with our products, and renewals of PCS. We sell our products through both our direct sales force and our channel partners. As ofDecember 31, 2021 , we had delivered our cloud networking solutions to over 8,000 end customers worldwide. 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. 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, sales to our end customers Microsoft and Meta Platforms in fiscal 2019 collectively represented 40% of our total revenue, whereas sales to our end customer Microsoft in fiscal 2020 and 2021 amounted to 21.5% and 15.0% of our revenues, respectively, with our end customer Meta Platforms representing less than 10% of our revenues in both fiscal 2020 and 2021. While we experienced some decline in overall revenue in 2020, the decline in revenue from these large end customers in 2021 was more than offset by stronger sales to our enterprise and other cloud and service provider customers. In addition, we typically provide pricing discounts to large end customers, which may result in lower margins for the period in which such sales occur. We expect customer concentration with these large end customers to be cyclical and linked to new product introductions and customer investment cycles. We believe that cloud computing represents a fundamental shift from traditional legacy network architectures. As organizations of all sizes have moved workloads to the cloud, spending on cloud and next-generation data centers has increased rapidly, while traditional legacy IT spending has grown more slowly. 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. The markets for cloud networking solutions are highly competitive and characterized by rapidly changing technology, changing end-customer needs, evolving industry standards, frequent introductions of new products and services, and industry consolidation. We expect competition to intensify in the future as the market for cloud networking expands and existing competitors and new market entrants introduce new products or enhance existing products. Our future success is dependent upon our ability to continue to evolve and adapt to our rapidly changing environment. We must also continue to develop market-leading products and features that address the needs of our existing and new customers, and increase sales in the enterprise data center switching, and campus workspace markets. We intend to continue expanding our sales force and marketing activities in key geographies, as well as our relationships with channel, technology and system-level partners in order 18
--------------------------------------------------------------------------------
Table of Contents
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 ability to rapidly develop 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 with respect to the underlying merchant silicon architecture. The programmability of EOS has allowed us to expand our software applications to address the ever-increasing demands of cloud networking, including workflow automation, network visibility, analytics and network detection and response, and has further allowed us to integrate rapidly with a wide range of third-party applications for virtualization, management, automation, orchestration and network services. 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.
COVID-19 Update
The global coronavirus ("COVID-19") pandemic and the subsequent recovery in
demand, coupled with lower COVID-19 period capital investments and reduced labor
supply has led to, among other things, manufacturing disruptions, supply chain
shortages, increased component and supply chain costs, increased lead times,
extended demand planning horizons and increased purchase commitments, all of
which have impacted our business operations.
We continue to monitor and evaluate developments as the situation evolves, and
have prioritized the safety of our employees throughout this period. Our offices
across the globe have reopened with employees returning on a voluntary basis.
Our manufacturing and supply chain operations continue to experience significant
constraints, with component shortages, increased component and supply chain
costs and delays broadly impacting the industry as a whole. We continue to work
closely with our contract manufacturers and supply chain partners who have
experienced delays in component sourcing, workforce disruptions and governmental
restrictions on the production and export of their products. Although we have
worked diligently to drive improvements in these areas, including funding
additional working capital and incremental purchase commitments, these delays
have negatively impacted our ability to supply products to our customers on a
timely basis. We have extended our demand planning horizon, increased our
purchase commitments and expect to continue to invest in working capital to
address delays in component sourcing and the risk of future supply chain
disruptions, but we cannot be certain that such delays or disruptions will not
occur. In addition, inflation pressure in our supply chain and scarcity of some
materials needed to build our products have increased our cost of revenue and
may negatively impact our gross margin. Although the overall economy continues
to recover, several issues including inflation risk, supply chain bottlenecks
and COVID-19 variants have and may continue to impact the pace of the recovery.
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 and related mitigation
efforts, and the impact on our customers, partners, employees, contract
manufacturers and supply chain, all of which are uncertain and cannot be
predicted. However, any continued or renewed disruption in manufacturing and
supply resulting from the COVID-19 pandemic or related containment measures
could negatively impact our business. We also believe that any extended or
renewed COVID-19 related economic disruption could have a negative impact on
demand from our customers in future periods. Accordingly, current results and
financial condition discussed herein may not be indicative of future operating
results and trends.
19--------------------------------------------------------------------------------
Table of Contents
Results of Operations
Three Months Ended
Revenue, Cost of Revenue and Gross Margin (in thousands, except percentages)
Three Months Ended March 31,
2022 2021 Change in
$ $ $ %
Revenue
Product $ 724,718 $ 539,145 $ 185,573 34.4 %
Service 152,348 128,417 23,931 18.6
Total revenue 877,066 667,562 209,504 31.4
Cost of revenue
Product 293,809 218,433 75,376 34.5
Service 29,412 23,857 5,555 23.3
Total cost of revenue 323,221 242,290 80,931 33.4
Gross profit $ 553,845 $ 425,272 $ 128,573 30.2 %
Gross margin 63.1 % 63.7 %
Revenue by Geography (in thousands, except percentages)
Three Months Ended March 31,
2022 % of Total 2021 % of Total
Americas $ 664,377 75.7 % $ 501,872 75.2 %
Europe, Middle East and Africa 134,805 15.4 96,274 14.4
Asia-Pacific 77,884 8.9 69,416 10.4
Total revenue $ 877,066 100.0 % $ 667,562 100.0 %
Revenue
Product revenue primarily consists of sales of our switching and routing
products, and software licenses. Service revenue is primarily derived from sales
of PCS contracts, 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 increased $185.6 million , or 34.4%, for the three months ended
March 31, 2022 compared to the same period in 2021. The increase was primarily
driven by increased demand for our switching and routing products from our
existing customers, with strong contributions from across our customer base. In
addition, we added new customers in the period, as we continued to expand our
presence in the enterprise market. Service revenue increased $23.9 million , or
18.6%, in the three months ended March 31, 2022 , compared to the same period in
2021, as a result of continued growth in initial and renewal PCS contracts as
our customer installed base has continued to expand. International revenues
decreased slightly from 24.8% of total revenue in the three months ended March
31, 2021 to 24.3% of total revenues in the three months ended March 31, 2022 ,
which was primarily due to reduced purchases from large global customers in the
Asia-Pacific region . We continued to experience competitive pricing pressure on
our products and services.
Cost of Revenue and Gross Margin
Cost of product revenue primarily consists of amounts paid for inventory to our third-party contract manufacturers and merchant silicon vendors, overhead costs of our manufacturing operations including freight, and other costs associated with manufacturing our products and managing our inventory and supply chain. Cost of service revenue primarily consists of personnel and other costs associated with our global customer support and services organizations. Cost of revenue increased$80.9 million , or 33.4% for the three months endedMarch 31, 2022 compared to the same period in 2021, which was primarily driven by a corresponding increase in product and service revenues, coupled with an increase in supply chain costs due to increased production capacity, component and other supply chain costs and higher volumes.
Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of
20--------------------------------------------------------------------------------
Table of Contents
factors, including pricing pressure on our products and services due to competition, the mix of sales to large end customers who generally receive lower pricing, the mix of products sold, manufacturing-related costs, including costs associated with supply chain sourcing activities, merchant silicon costs, and excess/obsolete inventory write-downs, including charges for excess/obsolete component inventory held by our contract manufacturers. We expect our gross margin to fluctuate over time, depending on the factors described above. Gross margin decreased from 63.7% to 63.1% for the three months endedMarch 31, 2022 compared to the same period in 2021. The decrease was primarily driven by higher supply chain costs, which were partly offset by improved product margins due to a reduced proportion of our sales to larger end customers who generally receive larger discounts.
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,
2022 2021 Change in
$ $ $ %
Operating expenses:
Research and development $ 172,006 $ 132,487 $ 39,519 29.8 %
Sales and marketing 80,739 71,020 9,719 13.7
General and administrative 23,113 15,473 7,640 49.4
Total operating expenses $ 275,858 $ 218,980 $ 56,878 26.0 %
Research and development
Research and development expenses consist primarily of personnel costs,
prototype expenses, third-party engineering costs, and an allocated portion of
facility and IT costs. Our research and development efforts are focused on new
product development and maintaining and developing additional functionality for
our existing products, including new releases and upgrades to our EOS software
and applications. We expect our research and development expenses to increase in
absolute dollars as we continue to invest in software development in order to
expand the capabilities of our cloud networking platform, introduce new products
and features, and continue to invest in our technology.
Research and development expenses increased $39.5 million , or 29.8%, in the
three months ended March 31, 2022 compared to the same period in 2021. The
increase in the three months ended March 31, 2022 was primarily due to a $21.4
million increase in new product introduction costs, including third party
engineering and other product development costs, and an $8.9 million increase in
personnel costs driven by headcount growth.
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. We expect our sales and marketing expenses to increase in absolute dollars as we continue to expand our sales and marketing efforts worldwide. Sales and marketing expenses increased$9.7 million , or 13.7%, for the three months endedMarch 31, 2022 compared to the same period in 2021. The increase in the three months endedMarch 31, 2022 included$11.0 million in personnel-related costs mostly driven by an increase in headcount and sales incentive compensation.
General and administrative
General and administrative expenses consist primarily of personnel costs and professional services costs. General and administrative personnel costs include those for certain executive functions, as well as finance, human resources and legal functions. Our professional services costs are primarily related to external legal, accounting and tax services. General and administrative expenses increased$7.6 million , or 49.4%, in the three months endedMarch 31, 2022 compared to the same period in 2021. The increase for the three months endedMarch 31, 2022 was primarily related to$5.3 million in personnel-related costs, which primarily consisted of increased stock-based compensation expenses.
Other Income, Net (in thousands, except percentages)
Other income, net consists primarily of interest income from our cash, cash
equivalents and marketable securities, gains and losses on our equity
investments in privately-held companies and marketable securities, and foreign
currency
21--------------------------------------------------------------------------------
Table of Contents
transaction gains and losses. We expect other income, net may fluctuate in the
future as a result of the re-measurement of our 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,
2022 2021 Change in
$ $ $ %
Other income, net:
Interest income $ 2,428 $ 2,045 $ 383 18.7 %
Unrealized gain on equity investments 28,497 - 28,497 100.0
Other income (expense), net 555 (470) 1,025 218.1
Total other income, net $ 31,480 $ 1,575 $ 29,905 1,898.7 %
The increase in other income, net was driven by a $28.5 million unrealized
gain on our equity investments. For additional information, refer to Note 2 -
Fair Value Measurement and Investments in the notes to the condensed
consolidated financial statements included in Part I, Item 1, of this Quarterly
Report on Form 10-Q.
Provision for 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 toU.S. income tax. Generally, ourU.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, 2022 2021 Change in $ $ $ % Income before income taxes$ 309,467 $ 207,867 $ 101,600 48.9 % Provision for income taxes 37,208 27,501 9,707 35.3 % Effective tax rate 12.0 % 13.2 % For the three months endedMarch 31, 2022 and 2021, we recorded a provision of$37.2 million and$27.5 million for income taxes, respectively. The increase in income taxes was primarily due to an overall increase in pre-tax income, combined with a favorable change in jurisdictional mix in earnings in the three months endedMarch 31, 2022 , as compared to the same period in 2021.
Liquidity and Capital Resources
Our principal sources of liquidity are cash, cash equivalents, marketable securities, and cash generated from operations. As ofMarch 31, 2022 , our total balance of cash, cash equivalents and marketable securities was approximately$3.4 billion , of which approximately$600.1 million was held outside of theU.S. in our foreign subsidiaries. Our cash, cash equivalents and marketable securities are held for general business purpose including the funding of working capital. 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. 22
--------------------------------------------------------------------------------
Table of Contents
© Edgar Online, source
