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 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. OverviewArista 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. 17
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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 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 collectively represented 40% of our revenue, and benefited from
certain factors that are not expected to repeat in fiscal 2020. Consequently,
the percentage of our revenue from these customers in fiscal 2020 is expected to
decline, which will contribute to an expected year-over-year decline in our
revenue for fiscal 2020. 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
The global coronavirus ("COVID-19") pandemic and related shelter in place,
travel and social distancing restrictions imposed by governments around the
world in an effort to contain or slow its spread have 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. We have prioritized the protection of our
employees during this pandemic and, as a result, have closed our offices across
the globe (including our corporate headquarters) limiting access to only those
employees providing essential activities, instructed employees to work from
home, and implemented travel restrictions. We continue to work closely with our
contract manufacturers and supply chain partners who have experienced delays in
component sourcing and 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 expect to continue to invest in working capital as supply
availability improves in order to address the risk of future COVID-19 related
supply chain disruptions, but we cannot be certain that such disruptions will
not occur.
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, breadth and duration of
containment measures such as restrictions on travel and transportation, 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
related containment
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measures 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 have experienced some strength in demand from our cloud titan customers, we expect this may be offset by longer sales cycles with new prospects in the campus and enterprise markets, contributing to an expected year-over-year decline in revenue for the year endingDecember 31, 2020 . Accordingly, current results and financial condition discussed herein may not be indicative of future operating results and trends. In response to potential future COVID-19 related disruptions to our business, we continue to carefully review our investment and spending plans, cautiously managing discretionary spending while maintaining an ongoing 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 OnFebruary 5, 2020 , we acquiredBig Switch Networks, Inc. ("Big Switch") a network monitoring and software-defined networking pioneer headquartered inSanta 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 and Six Months EndedJune 30, 2020 Compared to Three and Six Months EndedJune 30, 2019 Revenue, Cost of Revenue and Gross Profit (in thousands, except percentages) Three Months Ended June 30, Six Months Ended June 30, 2020 2019 Change in 2020 2019 Change in $ $ $ % $ $ $ % Revenue Product$ 421,413 $ 513,171 $ (91,758 ) (17.9 )%$ 832,319 $ 1,018,586 $ (186,267 ) (18.3 )% Service 119,157 95,150 24,007 25.2 231,280 185,159 46,121 24.9 Total revenue 540,570 608,321 (67,751 ) (11.1 ) 1,063,599 1,203,745 (140,146 ) (11.6 ) Cost of revenue Product 176,432 200,534 (24,102 ) (12.0 ) 340,061 398,686 (58,625 ) (14.7 ) Service 20,049 17,596 2,453 13.9 41,198 34,298 6,900 20.1 Total cost of revenue 196,481 218,130 (21,649 ) (9.9 ) 381,259 432,984 (51,725 ) (11.9 ) Gross profit$ 344,089 $ 390,191 $ (46,102 ) (11.8 )%$ 682,340 $ 770,761 $ (88,421 ) (11.5 )% Gross margin 63.7 % 64.1 % 64.2 % 64.0 %
Revenue by Geography (in thousands, except percentages)
Three Months Ended June 30, Six Months Ended June 30,
2020 % of Total 2019 % of Total 2020 % of Total 2019 % of Total
Americas $ 435,829 80.7 % $ 446,370 73.4 % $ 836,489 78.7 % $ 886,008 73.6 %
Europe ,
Middle East
and Africa 63,977 11.8 112,060 18.4 136,601 12.8 223,329 18.6
Asia-Pacific 40,764 7.5 49,891 8.2 90,509 8.5 94,408 7.8
Total
revenue $ 540,570 100.0 % $ 608,321 100.0 % $ 1,063,599 100.0 % $ 1,203,745 100.0 %
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 $91.8 million , or 17.9%, and $186.3 million , or 18.3%,
for the three and six months ended June 30, 2020 , respectively, compared to the
same periods in 2019. These decreases were primarily driven by the recognition
of $38.1 million and $121.0 million of deferred revenue related to customer
acceptance of prior period sales transactions in the three
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and six months endedJune 30, 2019 , respectively and some COVID-19 related supply constraints in the first half of fiscal 2020 resulting in extended lead times and constrained shipments to customers. Service revenue increased$24.0 million , or 25.2%, and$46.1 million , or 24.9%, in the three and six months endedJune 30, 2020 , compared to the same periods 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 19.3% and 21.3% of total revenues in the three and six months endedJune 30, 2020 , respectively, down from 26.6% and 26.4% compared to the same periods in the prior year. The decrease was primarily due to lower demand in our European region, combined with a move towardU.S. deployments by certain of our large end customers. We continued to experience competitive pricing pressure on our products and services. 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$21.6 million , or 9.9%, and$51.7 million , or 11.9%, for the three and six months endedJune 30, 2020 , respectively, compared to the same periods in 2019. These decreases were primarily 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 and obsolete inventory write-downs, including charges for excess and 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 decreased from 64.1% to 63.7% for the three months endedJune 30, 2020 , and increased from 64.0% to 64.2% for the six months endedJune 30, 2020 , compared to the same periods in 2019. Gross margin in each period was negatively impacted by customer mix with higher discounts on larger volume transactions. In addition, we incurred incremental COVID-19 related supply chain costs in current periods that were largely offset by decreased product transition costs, including lower excess and obsolete inventory charges. 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 EndedJune 30 ,
Six Months Ended
2020 2019 Change in 2020 2019 Change in
$ $ $ % $ $ $ %
Operating
expenses:
Research and
development $ 111,544 $ 114,295 $ (2,751 ) (2.4 )% $ 224,698 $ 233,964 $ (9,266 ) (4.0 )%
Sales and
marketing 51,237 53,040 (1,803 ) (3.4 ) 108,323 104,093 4,230 4.1
General and
administrative 14,319 16,019 (1,700 ) (10.6 ) 32,668 31,525 1,143 3.6
Total
operating
expenses $ 177,100 $ 183,354 $ (6,254 ) (3.4 )% $ 365,689 $ 369,582 $ (3,893 ) (1.1 )%
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 pandemic, we plan to tightly manage our
spending in fiscal 2020, and as a result research and development expenses in
fiscal 2020 may decrease from prior year levels.
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Research and development expenses decreased$2.8 million , or 2.4%, and$9.3 million , or 4.0%, in the three and six months endedJune 30, 2020 , respectively, compared to the same periods in 2019. The decrease in the three months endedJune 30, 2020 was primarily due to a decrease in new product introduction costs in the period combined with some COVID-19 related reductions in travel costs. The decrease in the six months endedJune 30, 2020 was primarily due to lower 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. 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 fiscal 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 fiscal 2019. Sales and marketing expenses decreased$1.8 million , or 3.4%, for the three months endedJune 30, 2020 compared to the same period in 2019. The decrease primarily resulted from COVID-19 related reductions in marketing and travel expenses, partially offset by increased salaries and stock-based compensation due to increased headcount. The increase of$4.2 million , or 4.1%, in the six months endedJune 30, 2020 compared to the same period in 2019, was primarily driven by an increase in salaries and stock-based compensation due to increased headcount, and an increase of$3.7 million in severance and other acquisition-related expenses from the Big Switch acquisition. This increase was partially offset by a reduction in travel expenses and other sales and marketing activities due to COVID-19. 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 decreased$1.7 million , or 10.6%, in the three months endedJune 30, 2020 compared to the same period in 2019. The decrease was primarily driven by a decline of$1.2 million in personnel-related costs. The increase of$1.1 million , or 3.6%, for the six months endedJune 30, 2020 compared to the same period in 2019 was primarily related to severance and other acquisition-related expenses from the Big Switch acquisition, partially offset by a reduction in litigation-related activities due to the settlement of our litigation with Optumsoft inDecember 2019 . Other Income, Net (in thousands, except percentages) Other income 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 that interest income from our fixed-income marketable securities will decline for the year endingDecember 31, 2020 as a result of lower interest rates. In addition, we expect other income 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 returns on our cash and cash equivalents and marketable securities, and foreign currency exchange rate fluctuations. Three Months EndedJune 30 ,
Six Months Ended
2020 2019 Change in 2020 2019 Change in
$ $ $ % $ $ $ %
Other income,
net:
Interest income $ 8,668 $ 13,107 $ (4,439 ) (33.9 )% $ 20,330 $ 25,005 $ (4,675 ) (18.7 )%
Gain on
investments in
privately-held
companies - - - - - 1,150 (1,150 ) (100.0 )
Other income
(expense), net (412 ) 704 (1,116 ) (158.5 ) 83 (11 ) 94 854.5
Total other
income, net $ 8,256 $ 13,811 $ (5,555 ) (40.2 )% $ 20,413 $ 26,144 $ (5,731 ) (21.9 )%
The unfavorable change in Other income, net, during the three and six months
ended June 30, 2020 as compared to the same periods in 2019 was primarily driven
by a decrease in interest income from our fixed-income marketable securities
caused by reduced interest rates. In addition, we recorded a gain on our
investments in privately-held companies in the six months ended June 30, 2019 ,
which did not recur in the current period.
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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 June 30, Six Months Ended June 30, 2020 2019 Change in 2020 2019 Change in $ $ $ % $ $ $ % Income before$ 175,245 $ 220,648 $ (45,403 ) (20.6 )%$ 337,064 $ 427,323 $ (90,259 ) (21.1 )% income taxes Provision for 30,452 31,397 (945 ) (3.0 )% 53,840 37,043 16,797 45.3 % income taxes Effective tax 17.4 % 14.2 % 16.0 % 8.7 % rate For the three and six months endedJune 30, 2020 , we recorded expenses of$30.5 million and$53.8 million for income taxes, respectively. For the three and six months endedJune 30, 2019 , we recorded expenses of$31.4 million and$37.0 million , respectively. Income taxes for the three months endedJune 30, 2020 included lower tax benefits realized from stock-based compensation. The remaining changes in the income taxes were attributable to the overall decrease in worldwide earnings. Liquidity and Capital Resources Our principal sources of liquidity are cash, cash equivalents, marketable securities, and cash generated from operations. As ofJune 30, 2020 , our total balance of cash, cash equivalents and marketable securities was approximately$2.8 billion , of which approximately$428.9 million was held outside theU.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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