What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-08-01 compared with 2023-05-02 · 71 added, 62 removed, 158 unchanged (46% of the section changed)

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We have worked diligently to drive improvements in these areas, including funding additional working capital and incremental purchase commitments, and have begun to see some reduction in customer lead times on certain products.

As customer lead times improve more broadly, we have seen and expect to continue to see a commensurate reduction in visibility to customer demand and a gradual return to a somewhat shorter demand-planning horizon.

While inventory and working capital levels may continue to increase and remain elevated in the near term, we expect that purchase commitments will continue to decline as supplier lead times begin to shorten.

Although these elevated inventory positions largely relate to early life cycle products, we cannot be certain that we will be able to sell this inventory which may result in excess and obsolete inventory charges in the future.

Over time, the recovery of capacity should allow us to ship products against previously committed deployment plans and accelerate some deployments where needed, while trying to limit building customer inventory.

On this basis, we now expect some shipments against these deployment schedules to extend into 2024.

As customer lead times reduce more broadly, we have seen and expect to continue to see a commensurate reduction in visibility to customer demand and a gradual return to somewhat shorter demand-planning horizons which has resulted in lower demand levels.

Given the shipment and order patterns described above, near term revenue trends may not be reflective of current demand levels, but will benefit from deployment plans that had been previously committed.

While inventory and working capital levels may continue to increase and remain elevated in the near term, we expect that purchase commitments will continue to decline as supplier lead times shorten.

Although these elevated inventory positions are largely related to early life cycle products, we cannot be certain that we will be able to sell all of this inventory, which may in the future result in excess and obsolete inventory charges.

In addition, inflation pressure in our supply chain, scarcity of some materials needed to build our products and disruptions to our manufacturing process have increased our cost of revenue and have impacted, and may continue to negatively impact our gross margin.

Our operating cash-flows have also been and may continue to be negatively impacted by significant component inventories on hand or at our contract manufacturers.

While we have seen some improvements in our supply chain and manufacturing operations, any remaining or new supply chain and manufacturing related constraints could negatively impact our business in future periods.

While we have seen improvements in our supply chain and manufacturing operations, any remaining or new supply chain and manufacturing related constraints 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.

Management continues to actively monitor the impact of these macroeconomic factors on the Company's financial condition, liquidity, operations, suppliers, industry, and workforce.

The extent of the impact of these factors 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, the impact on our customers, partners, employees, contract manufacturers and supply chain, all of which continue to evolve and are unpredictable;

Management continues to actively monitor the impact of macroeconomic factors on the Company's financial condition, liquidity, operations, suppliers, industry, and workforce.

The extent of the impact of these factors 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, the impact on our customers, partners, employees, contract manufacturers and supply chain, all of which continue to evolve and are unpredictable;

however, any continued or renewed disruption in manufacturing and supply resulting from these factors could negatively impact our business.

We also believe that our customers continue to grapple with the impact of these macroeconomic factors on their businesses and future investment plans, resulting in business

uncertainty and a more constrained approach to forecasts and orders.

We also believe that our customers, following a year of elevated purchases, must now consider changing technology roadmaps and priorities, including the need for the rapid deployment of AI and related technologies, resulting in some uncertainty as to future investment plans and a more constrained approach to some forecasts and orders in the near term.

In addition, any prolonged economic disruptions or further deterioration in the global economy could have a negative impact on demand from our customers in future periods.

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Results of Operations

Three Months Ended March 31, 2023 Compared to Three Months Ended March 31, 2022

Three and Six Months Ended June 30, 2023 Compared to Three and Six Months Ended June 30, 2022

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

Three Months Ended March 31,

2023 2022 Change in

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

2023 2022 Change in 2023 2022 Change in

$ $ $ % $ $ $ %

Product $ 1,261,537 $ 885,806 $ 375,731 42.4 % $ 2,433,631 $ 1,610,524 $ 823,107 51.1 %

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Revenue by Geography (in thousands, except percentages)

Three Months Ended March 31,

2023 % of Total 2022 % of Total

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

2023 % of Total 2022 % of Total 2023 % of Total 2022 % of Total

Americas $ 1,154,509 79.1 % $ 845,055 80.4 % $ 2,269,520 80.8 % $ 1,509,432 78.3 %

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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 $447.4 million, or 61.7%, for the three months ended March 31, 2023 compared to the same period in 2022.

The increase reflects strong demand for our switching and routing platforms from across our customer base, in particular healthy contributions from our large cloud customers.

In addition, service revenue increased $26.9 million, or 17.7% for the three months ended March 31, 2023, compared to the same period in 2022, as a result of continued growth in initial and renewal support contracts as our customer installed base has continued to expand.

International revenue represented 17.5% o f total revenue for the three months ended March 31, 2023, decreasing from 24.3% for the same period in the prior year, which was primarily driven by increased purchases from large global customers in our Americas region.

Product revenue increased $375.7 million, or 42.4%, and $823.1 million, or 51.1% for the three and six months ended June 30, 2023, respectively, compared to the same periods in 2022.

The increase reflects strong demand for our switching and routing platforms from across our customer base.

In addition, service revenue increased $31.3 million, or 18.8%, and $58.2 million, or 18.3% for the three and six months ended June 30, 2023, respectively, compared to the same period in 2022, as a result of continued growth in initial and renewal support contracts as our customer installed base has continued to expand.

International revenue represented 20.9% and 19.2% o f total revenue for the three and six months ended June 30, 2023, respectively, changing from 19.6% and 21.7% for the same periods in the prior year, which was primarily driven by changes in the geographic mix of sales to our large global customers.

Cost of Revenue and Gross Margin

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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 by $223.6 million, or 69.2% for the three months ended March 31, 2023 compared to the same period in 2022.

These increases were primarily driven by a corresponding increase in product and service revenues,

combined with an increase in provisions for excess/obsolete inventory.

Cost of revenue increased by $166.2 million, or 40.7%, and $389.8 million, or 53.3% for the three and six months ended June 30, 2023, respectively, compared to the same periods in 2022.

These increases were primarily driven by a corresponding increase in product and service revenues, combined with an increase in provisions for excess/obsolete inventory.

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 charges, 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 63.1% to 59.5% for the three months ended March 31, 2023 compared to the same periods in 2022.

The decrease was primarily driven by an increased proportion of our sales to large end customers who generally receive higher discounts and an increase in provisions for excess/obsolete inventory, partly offset by the leverage of fixed overhead costs on a higher revenue base.

In addition, our gross margins continue to be negatively impacted by significant material and logistics costs.

Gross margin decreased from 61.2% to 60.6% for the three months ended June 30, 2023, and decreased from 62.1% to 60.1% for the six months ended June 30, 2023, compared to the same periods in 2022.

These decreases were primarily driven by a higher mix of revenue from our larger customers combined with an increase in provisions for excess/obsolete inventory, partly offset by the leverage of fixed overhead costs on a higher revenue base.

Operating Expenses (in thousands, except percentages)

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

Three Months Ended March 31,

2023 2022 Change in

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

2023 2022 Change in 2023 2022 Change in

$ $ $ % $ $ $ %

Operating expenses:

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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 $29.4 million, or 17.1% in the three months ended March 31, 2023 compared to the same period in 2022.

The increases were primarily driven by an increase in personnel costs of $22.1 million for the three months ended March 31, 2023 compared to the same period in 2022 primarily due to headcount growth.

In addition, new product introduction costs increased by $7.0 million for the three months ended March 31, 2023 compared to the same period in 2022.

Research and development expenses increased $51.5 million, or 28.9%, and $80.9 million, or 23.1% in the three and six months ended June 30, 2023, respectively, compared to the same periods in 2022.

The increases were primarily driven by an increase in personnel costs of $27.6 million and $49.7 million for the three and six months ended June 30, 2023, respectively, compared to the same periods in 2022 primarily due to headcount growth.

In addition, new product introduction costs increased by $24.4 million and $31.5 million for the three and six months ended June 30, 2023, respectively, compared to the same periods in 2022.

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 $12.8 million, or 15.8% for the three months ended March 31, 2023 compared to the same period in 2022, which was primarily caused by increased personnel costs largely driven by headcount growth.

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 $18.6 million, or 23.4%, and $31.4 million, or 19.6% for the three and six months ended June 30, 2023, respectively, compared to the same periods in 2022, which was primarily caused by increased personnel costs largely driven by headcount growth, in addition to increased sales and marketing events and field demonstration costs.

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 $1.9 million, or 8.3% in the three months ended March 31, 2023

compared to the same period in 2022.

General and administrative expenses increased $3.5 million, or 15.5%, and $5.5 million, or 11.9% in the three and six months ended June 30, 2023, respectively, compared to the same periods in 2022.

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

Other income (expense), 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 transaction gains and losses.

Other income (expense), 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 equity securities, and foreign currency transaction gains and losses.

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 March 31,

2023 2022 Change in

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

2023 2022 Change in 2023 2022 Change in

$ $ $ % $ $ $ %

Other income (expense), net:

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Total other income (expense), net $ 56,339 $ (533) $ 56,872 10,670.2 % $ 68,485 $ 30,947 $ 37,538 121.3 %

The movements in other income (expense), net, were driven by an unrealized loss on equity investments of $5.6 million in the three months ended March 31, 2023 compared to an unrealized gain of $28.5 million in the same period in 2022.

This decrease in income was partly offset by an increase in interest income of $20.1 million in the three months ended March 31, 2023 due to higher interest rates.

The favorable movements in other income (expense), net, were driven by an unrealized gain on equity investments of $24.7 million in the three months ended June 30, 2023 compared to an unrealized loss of $5.1 million in the same period in 2022.

In addition, interest income increased $27.8 million and $47.9 million in the three and six months ended June 30, 2023, respectively, compared to the same periods in 2022 due to higher interest rates.

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 March 31,

2023 2022 Change in

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

2023 2022 Change in 2023 2022 Change in

$ $ $ % $ $ $ %

Income before income taxes $ 586,401 $ 362,320 $ 224,081 61.8 % $ 1,083,125 $ 671,787 $ 411,338 61.2 %

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Effective tax rate 16.1 % 17.4 % 14.3 % 14.9 %

Our provision for income taxes increased in the three months ended March 31, 2023, as compared to the same period in 2022, due to a corresponding increase in income before taxes, while our effective tax rate remained relatively stable over those same periods.

The decrease in the effective tax rates in the three and six months ended June 30, 2023, as compared to the same periods in 2022, was primarily due to an increase in tax benefits attributable to stock-based compensation.

Liquidity and Capital Resources

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

As of March 31, 2023, our total balance of cash, cash equivalents and marketable securities was approximately $3.3 billion, of which approximately $426.7 million was held outside the U.S.

As of June 30, 2023, our total balance of cash, cash equivalents and marketable securities was approximately $3.7 billion, of which approximately $455.2 million was held outside the U.S.

in our foreign subsidiaries.

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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.

we are required and unable to raise additional capital when desired, our business, operating results and financial condition may be adversely affected.

If we are required and unable to raise additional capital when desired, our business, operating results and financial condition may be adversely affected.

Cash Flows (in thousands)

Three Months Ended March 31,

Six Months Ended June 30,

Cash provided by operating activities $ 808,573 $ 318,235

Cash used in investing activities (21,747) (72,615)

Cash provided by (used in) investing activities (124,653) 172,959

Cash used in financing activities (97,635) (615,699)

Effect of exchange rate changes 429 (3,041)

Net increase in cash, cash equivalents and restricted cash $ 284,647 $ 14,233

Net increase (decrease) in cash, cash equivalents and restricted cash $ 586,714 $ (127,546)

Cash Flows from Operating Activities

During the three months ended March 31, 2023, cash provided by operating activities was $374.5 million, primarily from net income of $436.5 million and non-cash adjustments to net income of $18.6 million driven by stock-based compensation and depreciation and amortization, largely offset by an increase in deferred taxes associated with the capitalization of research and development costs under IRC Section 174.

These increases were partly offset by a net increase of $80.6 million in working capital requirements, which primarily consisted of a $393.0 million increase in inventory and an $81.9 million increase in inventory deposits to our contract manufacturers in response to a significant increase in business volume and increased product lead times.

These operating cash outflows were largely offset by cash inflows from a $153.2 million increase in accounts payable and accrued liabilities and a $108.2 million increase in income tax payables related to significant business volume and timing of payments.

During the six months ended June 30, 2023, cash provided by operating activities was $808.6 million, primarily from net income of $928.4 million and non-cash adjustments to net income of $16.9 million driven by stock-based compensation and depreciation and amortization, largely offset by an increase in deferred taxes associated with the capitalization of research and development costs under Section 174 of the Internal Revenue Code ("IRC").

These increases were partly offset by a net increase of $136.7 million in working capital requirements, which primarily consisted of a $574.6 million increase in inventory and a $137.0 million increase in inventory deposits to our contract manufacturers in response to a significant increase in business volume.

These operating cash outflows were largely offset by cash inflows from a $185.3 million increase in accounts payable and accrued liabilities due to an increase in business volume and timing of payments, and a $198.1 million increase in income tax payables related to an increase in taxable income, combined with an extension by the Internal Revenue Service ("IRS") of the due dates for estimated tax payments until October 2023.

In addition, we had cash inflows resulting from a decrease in accounts receivable of $143.4 million driven by strong collections, and an increase in deferred revenue of $43.7 million primarily resulting from an increase in customer PCS contracts.

During the three months ended March 31, 2022, cash provided by operating activities was $217.1 million, primarily from net income of $272.3 million, reduced by non-cash adjustments to net income of $35.4 million, and a net increase of $19.7 million in working capital requirements.

Cash outflows from the increase in working capital requirements primarily consisted of a $131.9 million increase in accounts receivables due to increased product and service billings, a $108.0 million increase in prepaid and other current assets primarily driven by increased inventory deposits to our contract manufacturers and product deferred cost of sales driven by higher product revenue deferrals, and a $43.5 million increase in inventory to help mitigate the impact of supply chain disruptions.

These operating cash outflows were largely offset by a $187.2 million increase in deferred revenue reflecting ongoing growth from PCS contracts, and increased product deferred revenue related to contracts with acceptance terms, and a $107.0 million increase in income taxes payable due to timing of payments, the impact of IRC Section 174 and an increase in pre-tax income.

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.

In addition, accounts receivable increased by $64.3 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.

Cash Flows from Investing Activities

During the three months ended March 31, 2023, cash used in investing activities was $21.7 million, consisting of purchases of available-for-sale securities of $861.6 million, and purchases of property and equipment of $5.6 million.

During the six months ended June 30, 2023, cash used in investing activities was $124.7 million, consisting of purchases of available-for-sale securities of $1,392.0 million, and purchases of property and equipment of $17.2 million.

These amounts were partially offset by proceeds from maturities and sales of marketable securities of $1,287.0 million.

During the three months ended March 31, 2022, cash used in investing activities was $72.6 million, primarily consisting of purchases of available-for-sale securities of $412.6 million, a business acquisition of $37.6 million, purchases of non-marketable equity investments of $11.7 million, and purchases of property and equipment of $14.9 million, partially offset by proceeds from maturities of marketable securities of $404.2 million.

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.

These amounts were partially offset by purchases of available-for-sale securities of $642.0 million, and purchases of property and equipment of $23.7 million.

Cash Flows from Financing Activities

During the three months ended March 31, 2023, cash used in financing activities was $68.4 million, consisting of payments for repurchases of our common stock from the open market of $82.3 million, and employee taxes withheld and paid of $9.2 million upon vesting of restricted stock units, partially offset by proceeds from the issuance of common stock under employee equity incentive plans of $23.1 million.

During the three months ended March 31, 2022, cash used in financing activities was $129.8 million, primarily consisting of payments for repurchases of our common stock from the open market of $136.2 million, partially offset by proceeds from the issuance of common stock under employee equity incentive plans of $19.2 million.

During the six months ended June 30, 2023, cash used in financing activities was $97.6 million, consisting of payments for repurchases of our common stock from the open market of $112.3 million, and employee taxes withheld and paid of $15.8 million upon vesting of restricted stock units, partially offset by proceeds from the issuance of common stock under employee equity incentive plans of $30.4 million.

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.

Stock Repurchase Program

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The 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 three months ended March 31, 2023, we repurchased a total of $82.3 million of our common stock.

As of March 31, 2023, the remaining authorized amount for repurchases under the Repurchase Program was $174.5 million.

During the three months ended June 30, 2023, we repurchased a total of $30.0 million of our common stock.

As of June 30, 2023, the remaining authorized amount for repurchases under the Repurchase Program was $144.5 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 March 31, 2023, we had lease payment obligations, net of immaterial sublease income, of $81.2 million, with $21.6 million payable within one year.

As of June 30, 2023, we had lease payment obligations, net of immaterial sublease income, of $78.0 million, with $21.6 million payable within one year.

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 March 31, 2023 , we had $2.9 billion of such purchase obligations, of which $2.4 billion are expected to be received within one year, and $0.5 billion are expected to be received after one year.

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

As of June 30, 2023, we had $2.2 billion of such purchase obligations, of which $1.9 billion are expected to be received within one year, and $0.3 billion are expected 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.

Accrued Income Taxes

As of March 31, 2023, we have recorded long-term tax liabilities of $90.8 million related to uncertain tax positions;

As of June 30, 2023, we have recorded long-term tax liabilities of $98.7 million related 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.

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Off-balance Sheet Arrangements

As of March 31, 2023, 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 June 30, 2023, 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