What changed in this filing

/stocks — the workspaceLOADING

Item 2. Management’s Discussion and Analysis

2022-11-01 compared with 2022-08-02 · 54 added, 55 removed, 175 unchanged (38% of the section changed)

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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.

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 approach, 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.

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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.

This variability in customer concentration has been linked to the timing of new product deployments and spending cycles with these customers, and we expect their contributions to return to more elevated levels during fiscal 2022.

We expect customer concentration with these large end customers to be cyclical and linked to new product introductions and customer investment cycles.

In addition, we have experienced and expect the collective revenue contribution from these same customers to return to more elevated levels during fiscal 2022 as they broadly adopt our newer 400 GbE and related networking products.

This variability in customer concentration has been linked to the timing of new product deployments and spending cycles with these customers, and we expect continued variability in our customer concentration and timing of sales on a quarterly and annual basis.

Furthermore, we typically provide pricing discounts to large end customers, which may result in lower margins for the period in which such sales occur.

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Macroeconomic Update

Global economic and business activities continue to face widespread macroeconomic uncertainties, including supply chain and labor shortages, inflation and monetary supply shifts, recession risks, the ongoing global coronavirus ("COVID-19") pandemic, and potential disruptions from the Russia-Ukraine conflict.

trade war with China.

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.

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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 have impacted, and may continue to negatively impact our gross margin.

While we continue to experience strong overall demand from customers, we believe ongoing supply disruptions combined with other supply chain related constraints, could impact our ability to fulfill this increased demand and as a result could negatively impact our business in future periods.

Our operating cash-flows have also been and may continue to be negatively impacted by increased component inventories on hand or at our contract manufacturers, awaiting supply of a limited number of scarce components necessary to build and ship the completed product.

While overall demand remains strong across our customers base, we believe ongoing supply disruptions combined with other supply chain related constraints, could impact our ability to fulfill this increased demand and as a result could negatively impact our business in future periods.

In addition, although our business has experienced limited disruption as a result of the Russia-Ukraine conflict, continued escalation of the conflict may negatively impact the global economy and our future operating results and financial condition.

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Results of Operations

Three and Six Months Ended June 30, 2022 Compared to Three and Six Months Ended June 30, 2021

Three and Nine Months Ended September 30, 2022 Compared to Three and Nine Months Ended September 30, 2021

Revenue, Cost of Revenue and Gross Margin (in thousands, except percentages)

Three Months Ended June 30, Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

2022 2021 Change in 2022 2021 Change in

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Revenue by Geography (in thousands, except percentages)

Three Months Ended June 30, Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

2022 % of Total 2021 % of Total 2022 % of Total 2021 % of Total

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Total revenue $ 1,176,801 100.0 % $ 748,697 100.0 % $ 3,105,758 100.0 % $ 2,123,578 100.0 %

Product revenue primarily consists of sales of our switching and routing products, and software licenses.

Product revenue primarily consists of sales of our switching and routing products, and related network applications.

Service revenue is primarily derived from sales of PCS contracts, which are 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 $319.3 million, or 56.4%, and $504.9 million, or 45.7%, for the three and six months ended June 30, 2022, respectively, compared to the same periods in 2021.

Product revenue increased $404.5 million, or 67.0%, and $909.4 million, or 53.2%, for the three and nine months ended September 30, 2022, respectively, compared to the same periods in 2021.

These increases reflect strong demand for our switching and routing platforms from across our customer base, including healthy contributions from our large cloud customers.

Supply chain constraints continued to impact our revenue performance in these periods and while changes in product deferred revenue impacted the timing of revenue recognition on a quarterly basis, it was not a net contributor to revenue growth for the six-month period ended June 30, 2022.

In addition, service revenue increased $25.2 million, or 17.9%, and $49.2 million, or 18.3%, in the three and six months ended June 30, 2022, compared to the same periods in 2021, as a result of continued growth in initial and renewal support contracts as our customer installed base has continued to expand.

International revenues represented 19.6% and 21.7% of total revenues in the three and six months ended June 30, 2022, respectively, decreasing from 27.3% and 26.1% for the same periods in the prior year, which was primarily driven by increased purchases from large global customers in our Americas region.

Supply chain constraints continued to impact our revenue performance in these periods and while changes in product deferred revenue impacted the timing of revenue recognition on a quarterly basis, it was not a net contributor to revenue for the nine-month period ended September 30, 2022.

In addition, service revenue increased $23.6 million, or 16.3%, and $72.7 million, or 17.6%, in the three and nine months ended September 30, 2022, compared to the same periods in 2021, as a result of continued growth in initial and renewal support contracts as our customer installed base has continued to expand.

International revenues represented 16.9% and 19.9% o f total revenues in the three and nine months ended September 30, 2022, respectively, decreasing from 25.5% and 25.8% for the same periods in the prior year, which was primarily driven by increased purchases from large global customers in our Americas region.

We continued to experience competitive pricing pressure on our products and services.

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Cost of service revenue primarily consists of personnel and other costs associated with our global customer support and services organizations.

Cost of revenue increased $155.5 million, or 61.4%, and $236.4 million, or 47.7%, for the three and six months ended June 30, 2022, respectively, compared to the same periods in 2021.

These increases were primarily driven by a corresponding

increase in product and service revenues, combined with an increase in material and logistics costs to mitigate supply chain constraints and to meet customer demand.

Cost of revenue increased $196.7 million, or 72.8%, and $433.2 million, or 56.6%, for the three and nine months

ended September 30, 2022, respectively, compared to the same periods in 2021.

These increases were primarily driven by a corresponding increase in product and service revenues, combined with an increase in material and logistics costs to mitigate supply chain constraints and to meet customer demand.

Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of 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 64.2% to 61.2% for the three months ended June 30, 2022, and decreased from 64.0% to 62.1% for the six months ended June 30, 2022, compared to the same periods in 2021.

Gross margin decreased from 63.9% to 60.3% for the three months ended September 30, 2022, and decreased from 64.0% to 61.4% for the nine months ended September 30, 2022, compared to the same periods in 2021.

The decrease in each period was primarily driven by an increased proportion of our sales to larger end customers who generally receive larger discounts and, increased material and logistics costs to mitigate supply chain constraints, partly offset by the impact of fixed overhead costs on a higher revenue base.

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Personnel costs also include stock-based compensation and travel expenses.

Three Months Ended June 30, Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

2022 2021 Change in 2022 2021 Change in

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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 $34.9 million, or 24.3%, and $74.4 million, or 27.0%, in the three and six months ended June 30, 2022, respectively, compared to the same periods in 2021.

The increases were primarily driven by an increase in personnel costs of $16.4 million and $25.3 million for the three and six months ended June 30, 2022, respectively, compared to the same periods in 2021 due to headcount growth.

In addition, new product introduction costs increased by $10.7 million and $32.0 million for the three and six months ended June 30, 2022, respectively, compared to the same periods in 2021.

Research and development expenses increased $34.7 million, or 22.7%, and $109.1 million, or 25.4%, in the three and nine months ended September 30, 2022, respectively, compared to the same periods in 2021.

The increases were primarily driven by an increase in personnel costs of $25.1 million and $50.5 million for the three and nine months ended September 30, 2022, respectively, compared to the same periods in 2021 due to headcount growth.

In addition, new product introduction costs increased by $5.5 million and $37.5 million for the three and nine months ended September 30, 2022, respectively, compared to the same periods in 2021.

Sales and marketing

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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 $8.7 million, or 12.4%, and $18.5 million, or 13.0%, for the three and six months ended June 30, 2022, respectively, compared to the same periods in 2021, which was primarily caused by increased personnel costs driven by headcount growth.

Sales and marketing expenses increased $11.7 million, or 16.7%, and $30.1 million, or 14.3%, for the three and nine months ended September 30, 2022, respectively, compared to the same periods in 2021, which was primarily caused by increased personnel costs driven by headcount growth.

General and administrative

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Our professional services costs are primarily related to external legal, accounting and tax services.

General and administrative expenses increased $2.0 million, or 9.5%, and $9.6 million, or 26.5%, in the three and six months ended June 30, 2022 compared to the same periods in 2021.

The increase in the three and six months ended June 30, 2022 included increased legal and professional fees, primarily driven by acquisitions during the first half of 2022.

The increase in the six months ended June 30, 2022 was also driven by an increase in personnel costs, including stock-based compensation.

General and administrative expenses increased $0.9 million, or 4.2%, and $10.6 million, or 17.9%, in the three and nine months ended September 30, 2022 compared to the same periods in 2021.

The increase in the nine months ended September 30, 2022 included an increase in personnel costs, and increased legal and professional fees, primarily driven by acquisitions during the first half of 2022.

Other Income (Expense), Net (in thousands, except percentages)

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We expect other income (expense), 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 June 30, Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

2022 2021 Change in 2022 2021 Change in

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Total other income (expense), net $ 6,817 $ 1,346 $ 5,471 406.5 % $ 37,764 $ 4,640 $ 33,124 713.9 %

The movements in other income (expense), net, during the three and six months ended June 30, 2022 as compared to the same periods in 2021 were primarily driven by the movements of the stock prices of our publicly-traded equity investment after its initial public offering in January 2022.

In addition, our interest income has increased as we gradually replace lower-coupon-rate fixed-income marketable debt securities upon maturity with those with higher coupon rates.

We expect our interest income to continue to increase for the remainder of 2022 as a result of higher interest rates.

The movements in other income (expense), net, during the three and nine months ended September 30, 2022 as compared to the same periods in 2021 were driven by an increase in interest income due to higher interest rates.

In addition, we had unrealized gains of $24.1 million in the nine months ended September 30, 2022 related to our equity investments.

Provision for Income Taxes (in thousands, except percentages)

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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,

Three Months Ended September 30, Nine Months Ended September 30,

2022 2021 Change in 2022 2021 Change in

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Effective tax rate 16.5 % 4.4 % 15.6 % 9.3 %

The increase in the effective tax rates in the three and six months ended June 30, 2022, as compared to the same periods in 2021, was primarily due to a decrease in the proportion of tax benefits attributable to stock-based compensation versus total pre-tax income.

The increase in the effective tax rates in the three and nine months ended September 30, 2022, as compared to the same periods in 2021, was primarily due to a decrease in the proportion of tax benefits attributable to stock-based compensation versus total pre-tax income.

Liquidity and Capital Resources

Our principal sources of liquidity are cash, cash equivalents, marketable securities, and cash generated from operations.

As of June 30, 2022, our total balance of cash, cash equivalents and marketable securities was approximately $2.9 billion, of which approximately $381.3 million was held outside the U.S.

As of September 30, 2022, our total balance of cash, cash equivalents and marketable securities was approximately $3.0 billion, of which approximately $436.8 million was held outside the U.S.

in our foreign subsidiaries.

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Cash Flows (in thousands)

Six Months Ended June 30,

Nine Months Ended September 30,

Cash provided by operating activities $ 452,340 $ 790,620

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Cash Flows from Operating Activities

During the six months ended June 30, 2022, cash provided by operating activities was $318.2 million, primarily from net income of $571.4 million and non-cash adjustments to net income of $19.8 million driven by stock-based compensation and depreciation and amortization, and partly offset by a net increase of $272.9 million in working capital requirements.

The increase in working capital requirements primarily consisted of a $202.1 million increase in inventory and a $158.1 million increase in prepaid expenses and other current assets, which reflected increased inventory purchases and inventory deposits to contract manufacturers to mitigate supply chain constraints and meet customer demand.

The increase in other current assets also reflected increased deferred product cost of sales due to a corresponding increase in deferred product revenue, as well as an increase in contract assets and other miscellaneous receivables.

During the nine months ended September 30, 2022, cash provided by operating activities was $452.3 million, primarily from net income of $925.4 million and non-cash adjustments to net income of $66.7 million driven by stock-based compensation and depreciation and amortization, and partly offset by a net increase of $539.7 million in working capital requirements.

The increase in working capital requirements primarily consisted of a $449.8 million increase in inventory, $69.0 million increase in prepaid expenses and other current assets, and $17.9 million in other assets, which reflected increased inventory purchases and inventory deposits to contract manufacturers to mitigate supply chain constraints and meet customer demand.

In addition, accounts receivable increased by $129.9 million due to increased product and service billings.

These operating cash outflows were partially offset by a $91.2 million increase in product and service deferred revenue driven by customer contracts with acceptance terms and PCS contracts, a $71.2 million increase in accounts payable, and a $10.8 million increase in income tax payables.

During the six months ended June 30, 2021, cash provided by operating activities was $518.0 million, primarily from net income of $377.3 million and non-cash adjustments to net income of $125.2 million driven by stock-based compensation and depreciation and amortization, and a net decrease of $15.5 million in working capital requirements.

The decrease in working capital requirements primarily consisted of a $95.3 million increase in product and service deferred revenue driven by customer contracts with acceptance terms and growth in PCS contracts, a $25.3 million decrease in accounts receivable due to strong collections, and a $20.0 million increase in accrued liabilities due to additional supply chain related obligations.

These cash inflows were partially offset by a $63.5 million increase in inventory and a $44.4 million increase in prepaid expenses primarily due to prepaid income taxes and deferred product cost of revenue.

These operating cash outflows were partially offset by a $73.5 million increase in accounts payable, and a $41.1 million increase in income tax payables.

During the nine months ended September 30, 2021, cash provided by operating activities was $790.6 million, primarily from net income of $601.6 million and non-cash adjustments to net income of $204.8 million driven by stock-based compensation and depreciation and amortization, and a net increase of $15.8 million in working capital requirements.

The increase in working capital requirements primarily consisted of a $96.0 million increase in inventory and a $71.3 million increase in prepaid expenses primarily due to prepaid income taxes and deferred product cost of revenue.

These cash outflows were largely offset by a $149.6 million increase in product and service deferred revenue driven by customer contracts with acceptance terms and growth in PCS contracts, and a $31.3 million increase in accrued liabilities due to additional supply chain and software development costs.

Cash Flows from Investing Activities

During the six months ended June 30, 2022, cash provided by investing activities was $173.0 million, consisting of proceeds from maturities of marketable securities of $829.7 million and proceeds from sale of marketable securities of $165.7 million, which was used to fund the business acquisitions and to repurchase our common stock.

During the nine months ended September 30, 2022, cash provided by investing activities was $299.2 million, consisting of proceeds from sales and maturities of marketable securities of $1,464.6 million.

These amounts were partially offset by purchases of available-for-sale securities of $973.5 million, and purchases of property and equipment of $34.2 million.

During the six months ended June 30, 2021, cash used in investing activities was $436.1 million, consisting of purchases of available-for-sale securities of $1,241.7 million, and purchases of property and equipment of $9.6 million, partially offset by proceeds from maturities of marketable securities of $819.8 million.

During the nine months ended September 30, 2021, cash used in investing activities was $861.4 million, consisting of purchases of available-for-sale marketable securities of $1,974.9 million, and purchases of property and equipment of $55.5 million, partially offset by proceeds from maturities of marketable securities of $1,158.7 million and proceeds from sale of marketable securities of $19.6 million.

Cash Flows from Financing Activities

During the six months ended June 30, 2022, cash used in financing activities was $615.7 million, consisting of payments for repurchases of our common stock from the open market of $619.9 million, and employee taxes withheld and paid of $18.8 million upon vesting of restricted stock units, offset partially by proceeds from the issuance of common stock under employee equity incentive plans of $23.0 million.

During the six months ended June 30, 2021, cash used in financing activities was $80.8 million, consisting of payments for repurchases of our common stock from the open market of $101.4 million, and employee taxes withheld and paid of $6.4 million upon vesting of restricted stock units, offset partially by proceeds from the issuance of common stock under employee equity incentive plans of $26.9 million.

During the nine months ended September 30, 2022, cash used in financing activities was $649.9 million, consisting of payments for repurchases of our common stock from the open market of $667.5 million, and employee taxes withheld and paid of $25.5 million upon vesting of restricted stock units, offset partially by proceeds from the issuance of common stock under employee equity incentive plans of $43.1 million.

During the nine months ended September 30, 2021, cash used in financing activities was $190.0 million, consisting of payments for repurchases of our common stock from the open market of $235.5 million, and employee taxes withheld and paid of $10.6 million upon vesting of restricted stock units, offset partially by proceeds from the issuance of common stock under employee equity incentive plans of $56.1 million.

Stock Repurchase Program

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The New Repurchase Program does not obligate us to acquire any of our common stock and may be suspended or discontinued by the company at any time without prior notice.

During the quarter ended June 30, 2022, we repurchased a total of $483.7 million of our common stock.

As of June 30, 2022, the remaining authorized amount for repurchases under the New Repurchase Program was $307.2 million.

During the quarter ended September 30, 2022, we repurchased a total of $47.6 million of our common stock.

As of September 30, 2022, the remaining authorized amount for repurchases under the New Repurchase Program was $259.6 million.

Refer to Note 6.

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We have operating lease arrangements for office space, data center, equipment and other corporate assets.

As of June 30, 2022, we had lease payment obligations, net of immaterial sublease income, of $82.1 million, with $11.9 million payable within 12 months.

As of September 30, 2022, we had lease payment obligations, net of immaterial sublease income, of $77.3 million, with $24.7 million payable within 12 months.

Purchase Obligations

Purchase obligations represent an estimate of all non-cancellable open purchase orders and contractual obligations, made either directly by Arista or by our contract manufacturers on our behalf, in the ordinary course of business for which we have not received the goods or services.

As of June 30, 2022, we had $4.47 billion of such purchase obligations, out of which $2.94 billion are expected to be received within 12 months, and $1.53 billion are expected to be received after one year.

As of September 30, 2022, we had $4.3 billion of such purchase obligations, of which $3.1 billion are expected to be received within 12 months, and $1.2 billion are e xpected to be received after one year.

These open purchase orders are considered enforceable and legally binding, and while we may have some limited ability to reschedule and adjust our requirements based on our business needs prior to the delivery of goods or performance of services, this can only occur with the agreement of the related supplier.

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In connection with the Tax Cuts and Jobs Act of 2017("TCJA"), we recorded a federal income tax payable for transition tax on the mandatory deemed repatriation of foreign earnings that will be payable over an eight-year period.

As of June 30, 2022, $6.3 million of long-term transition tax payable represents the remaining federal income tax payable due between one and three years.

In addition to the long-term transition tax payable, as of June 30, 2022, we have recorded long-term tax liabilities of $73.1 million related to uncertain tax positions;

As of September 30, 2022, $6.3 million of long-term transition tax payable represents the remaining federal income tax payable due between one and three years.

In addition to the long-term transition tax payable, as of September 30, 2022, we have recorded long-term tax liabilities of $75.8 million relate d to uncertain tax positions;

however, we are unable to make a reasonably reliable estimate of the timing of settlement, if any, of these future payments.

In addition, beginning in 2022, the TCJA eliminates the option to deduct research and development expenditures currently and requires taxpayers to capitalize and amortize them over five or fifteen years pursuant to IRC Section 174.

Although there is proposed legislation that would defer the capitalization requirement to later years, we have no assurance that the provision will be repealed or otherwise modified.

Consequently, we estimate the incremental cash tax impact resulting from the new regulations to be approximately $184.0 million for the year, of which the liability for the first six months of 2022 has been paid as of June 30, 2022;

however, we do not anticipate any material change to our effective tax rate.

While there is the potential for legislation that would defer the capitalization requirement to later years, we have no assurance that the provision will be repealed or otherwise modified.

Consequently, we estimate the incremental cash tax impact resulting from the

new regulations to be approximate ly $188.0 million for the year, of which the liability for the first nine months of 2022 has been paid as of September 30, 2022;

however, we do not anticip ate any material change to our effective tax rate.

Off-balance Sheet Arrangements

As of June 30, 2022, we did not have any relationships with any unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

As of September 30, 2022, we did not have any relationships with any unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Estimates

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis