ARISTA NETWORKS, INC.
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K, including the sections entitled “Business,” “Risk Factors,” “Use of Proceeds,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, as Section 21E of the Securities Exchange Act of 1934, as amended, which statements involve substantial risks and uncertainties. The words “believe,” “may,” “will,” “potentially,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “project,” “plan,” “predict,” “expect” and similar expressions that convey uncertainty of future events or outcomes are intended to identify forward-looking statements.
These forward-looking statements include, but are not limited to, statements concerning the following:
•our ability to maintain an adequate rate of revenue growth and our future financial performance, including our expectations regarding our revenue, cost of revenue, gross profit or gross margin and operating expenses;
•our belief that the cloud networking market is rapidly evolving and has a significant potential opportunity for growth;
•our ability to expand our leadership position in the network switch industry, including the areas of mobility, virtualization, network monitoring, cloud computing and cloud networks, and to develop new products and expand our business into new markets such as the campus workspace, enterprise data center and security markets;
•our ability to satisfy the requirements for cloud networking solutions and to successfully anticipate technological shifts and market needs, innovate new products, rapidly develop new features and applications, and bring them to market in a timely manner;manner including any increased adoption of new technology solutions or consumption models such as commoditized hardware technology or open source networking solutions;
•the demand for our solutions, products and services we offer;
•our business plan and our ability to effectively manage our growth;
•our ability to integrate and realize the benefits of our recent and future acquisitions;
•costs associated with defending intellectual property infringement and other claims and the potential outcomes of such disputes, such as thoseany claims discussed in “Legal Proceedings,” including the OptumSoft litigation matters;Proceedings”;
•our ability to retain and increase sales to existing customers and attract new end customers, including large end customers;
•the budgeting cycles and purchasing practices of end customers, including large end customers who may receive lower pricing terms due to volume discounts;discounts or who may elect to re-assign allocations to multiple vendors based upon specific network roles or projects;
•the growth and buying patterns of our large end customers in which large bulk purchases may or may not occur in certain quarters;
•our inability to fulfill our end customers’ orders due to supply chain delays, access to key commodities or technologies or events that impact our manufacturers or their suppliers;suppliers such as the recent U.S. trade wars or the impact of the COVID-19 pandemic;
•our expectations regarding the impact of the COVID-19 pandemic on our business;
•the deferral or cancellation of orders by end customers, warranty returns or delays in acceptance of our products;
•our ability to further penetrate our existing customer base and sell more complex and higher-performance configurations of our products;
•our ability to displace existing products in established markets;
•our belief that increasing channel leverage will extend and improve our engagement with a broad set of customers;
•our plans to continue to expand our sales force, marketing activities and relationships with channel, technology and system-level partners;
•our plans to invest in our research and development;
•our ability to timely and effectively scale and adapt our existing technology;
•the benefits realized by our customers in their use of our products and services including lower total cost of ownership;
•our ability to expand our business domestically and internationally;
•the effects of increased competition in our market and our ability to compete effectively;
•the effects of seasonal and cyclical trends on our results of operations;
•our expectations concerning relationships with third parties;
•the attraction and retention of qualified employees and key personnel;
•our ability to maintain, protect and enhance our brand and intellectual property;
•economic and industry trends;
•estimates and estimate methodologies used in preparing our financial statements;
•future trading prices of our common stock;
•our belief that we have adequately reserved for uncertain tax positions;
•global economic and political conditions that introduce instability into the U.S. economy;
•the impact of global and domestic tax reform, including the Tax Cuts and Jobs Act of 2017;reform;
•the impact of tariffs imposed by the U.S. on goods from other countries and tariffs imposed by other countries on U.S. goods, including the tariffs recently implemented and additional tariffs that have been proposed by the U.S. government on various imports from China;goods;
•our belief that our existing cash and cash equivalents together with cash flow from operations will be sufficient to meet our working capital requirements and our growth strategies for the foreseeable future; and
•our ability to identify, complete and realize the benefits of future acquisitions of or investments in complementary companies, products, services or technologies;technologies.
These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the section titled “Risk Factors” and elsewhere in this Annual Report on Form 10-K. Moreover, we operate in a very competitive and rapidly changing environment, and new risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Annual Report on Form 10-K may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. You should not rely upon forward-looking statements as predictions of future events.
The forward-looking statements made in this Annual Report on Form 10-K relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Annual Report on Form 10-K to reflect events or circumstances after the date of this Annual Report on Form 10-K or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make.
PART I
Item 1. Business
In recent years, we have sought to bring the core of our cloud networking platform is EOS, which was purpose-built to be fully programmableoperational consistency and highly modular. The programmability of EOS has allowed us to create a set of software applications that address the requirementsprinciples of cloud networking to the broader enterprise and campus markets with our Cognitive Cloud Networking approach. Our cognitive single-tier SplineTM campus network extends EOS across the campus workspace and the data center.In addition, we acquired Mojo Networks, Inc. (“Mojo”), the inventor of Cognitive WiFiTM to extend these same cognitive principles to the wireless network.CloudVision®, our network-wide approach for workload orchestration and automation, leverages EOS and Cognitive WiFiTM features, to deliver a turnkey workflow orchestration and automation solution for cloud networking to our enterprise customers.
In the early part of 2020, we acquired Big Switch Networks, a pioneer in network monitoring software. These Big Switch capabilities, integrated with the Arista switching portfolio, power the DANZ Monitoring Fabric (DMF), a leading network monitoring solution. We also completed the acquisition of Awake Security, an AI-driven network detection and response (NDR) security company, at the end of 2020. We believe the combination of DMF and Awake Security capabilities delivers the next generation of operationally efficient network security and visibility.
In addition, we continued to expand our data center and campus network product portfolio during 2020 including workflow automation, networkthe introduction of the 750 Series modular chassis, a modular campus PoE switch that delivers high performance, security, visibility and analytics,power network security and has also allowed us to rapidly integrate with a wide range of third-party applications for virtualization, management, automation, orchestration and network services. visibility.
Since we began shipping our products, we have grown rapidly, and, according to Crehan Research,market research, we have achieved the second largest market share in data center 10/25/40/50/100 Gigabit Ethernet switch ports and revenue, excluding blade switching, sold in 2018.China. We have been profitable and cash flow positive for each year since 2010.
We sell our products through both our direct sales force and our channel partners. 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. Our customers include six of the largest cloud services providers based on annual revenue.revenue.
We compete primarily in the data center switching market for 10 Gigabit Ethernet and above, excluding blade switches. We added advanced routing capabilities to our R-Series switches, which in addition to switching address the Data Center Interconnect (DCI) market and parts of the wide area networking routing market. We more recently began to compete in the enterprise campus market for 1 Gigabit Ethernet switching and above and in the cloud-managed wireless networking market. In addition, our acquisitions of Big Switch Networks and Awake Security enhance our ability to address a portion of the Network Monitoring and Network Detection and Response (NDR) security markets.
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 Customers
As of December 31, 2020, we had delivered our cloud networking solutions to over 7000 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
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and others. For the years ended December 31, 2020, 2019 and 2018, purchases by Microsoft accounted for more than 10% of our total revenue.
Cloud computingNetworking and Digital Transformation Market Drivers
Digital transformation is fundamentally changing the way IT infrastructure is built and how applications are delivered.delivered from a cloud environment. In cloud computing, applications are distributed across thousands of servers. These servers are connected
with high-speed network switches that, together, form a pool of resources that allows applications to be rapidly deployed and cost-effectively updated. Cloud computing enables ubiquitous and on-demand network access to these applications from internet-connected devices including personal computers, tablets, IoT (Internet of Things) devices, and smartphones.
Nearly all consumer applications today are delivered as cloud services. Enterprise applications are rapidly moving to the cloud as well since cloud services are easier and more cost effective to deploy, scale and operate than traditional applications. Internet leaders like Amazon, eBay, Facebook, Google, Microsoft and Yahoo!Microsoft pioneered the development of large-scale cloud data centers in order to meet the growing demands of their users, including business customers. Enterprises and service providers around the world are adopting cloud computing technologies in order to achieve similar performance improvements and cost reductions.
The aggregate network bandwidth in the cloud can be orders of magnitude higher than typical legacy data center networks. Therefore, the networks in such cloud environments must be architected and built in a new way. We refer to these next-generation data center networks as cloud networks. Cloud networks must deliver high capacity, high availability and predictable performance, and must be programmable to allow integration with third-party applications for network, management, automation, orchestration and network services.
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Examples of key secular trends driving network transformation are illustrated below:
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Limitations of Traditional Enterprise Data Center and Campus Networks
The much larger scale of cloud networks requires much higher network availability since network outages in the cloud are very expensive in terms of customer impact.costly to customers. Traditional network switches have evolved, and the features and capabilities of their operating system have expanded over many years without addressing the structural deficiencies of their underlying software architectures, making it difficult to achieve high network switch reliability.
Some networking vendors have built products that use proprietary protocols to address the scaling needs of next-generation data centers. However, proprietary protocols are generally not acceptable todisfavored by internet companies or cloud service providers because they create vendor lock-in.
Legacy enterprise networks are generally not programmable and, as a result, are extremely difficult to integrate with third-party applications for network management, automation, orchestration and network services. This lack of integration forces customers to continue to rely on time consuming, error-prone manual processes that may be cost-prohibitive.
Traditional enterprise wired and wireless campus networks suffer from complexmust cope with an ever-increasing number of endpoint IoT (Internet of Things) devices for users to be connected anywhere. Campus administrators have sought to address the resulting increased network complexities and bottlenecks brought on bythrough the adoption of a myriad of platforms, operating systems, proprietary features and network management tools. Coupled with the explosive growth of IoT and endpoints as well as the requirement for workloads, users and devices to be connected anywhere, the operational costs of managing these complexities have become prohibitive.
Our Cloud Networking Solutions
Our cloud networking solutions consist of EOS, our Extensible Operating System, a set of networking applications and our Gigabit Ethernet platforms. At the core of our cloud networking platform is EOS, which was architected to be fully programmable, modular and highly modular.
reliable. The programmability of EOS has allowed us to create a set ofexpand our software applications and application programming interfaces, or APIs, thatto address the requirementsever increasing demands of cloud networking, including workflow automation, network visibility, analytics and analytics,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.
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An overview of our cloud networking solutions is shown below:
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The key benefits of our cloud networking solutions are as follows:
Capacity, Performance and Scalability
Our cloud networking platform enables data center networks to scale to hundreds of thousands of physical servers and millions of virtual machines with the least number of switching tiers. We achieve this by leveraging standard protocols to meet the scale requirements of cloud computing. We have used active-active Layer 2 and Layer 3 network topologies to enable customers to build extremely large and resilient networks.
High Availability
Our highly modular EOS software architecture was designed to be fault-isolating and self-healing in order to deliver higher stabilityavailability compared to legacy network operating systems. In addition, our customers can non-disruptively upgrade our switches running in the network using our Smart System Upgrade, or SSU application.application, without interrupting the network service.
Open and Programmable
Our EOS software was purpose-built to offer programmable interfaces throughout all levels of our software. This has allowed us to integrate our cloud networking platform with a wide range of leading third-party applications. For example, we support VMware NSX, OpenStackOpenConfig/YANG and Microsoft System Center for orchestration and fast provisioning, enabling true workload mobility and automatic provisioning of physical switches. We enable customers, through application programming interfaces,Application Programming Interfaces (APIs), to write their own scripts to customize and optimize their networks. In addition, we support a wide range of software-defined network controllers via our OpenFlow and DirectFlow interfaces.
Workflow Automation
Our EOS software enables enterprises to provision networking resources in minutes with no manual intervention through our Zero Touch Provisioning. We also natively support Ansible, CFEngine, Chef, Puppet, virtual network orchestration applications and third-party management tools. CloudVision, a network-wide approach for workload orchestration and workflow automation, delivers a turnkey solution to enterprises looking to modernize their data centers for cloud networking. CloudVision extends the same EOS architectural approach across the network for state, topology, monitoring and visibility. This enables enterprises to move to cloud-class automation without needing significant internal development. Finally, EOS embraces the DevOps model, which is a software development method that combines development and operations, to provision and monitor servers, storage and network resources in a unified fashion.
Network Visibility
Our EOS software provides a set of tools and applications that proactively monitor, detect and notify network managers when network issues arise, delivering real-time data to third-party managementnetwork performance and security applications including Corvil, ExtraHop, Riverbed and Splunk to provide detailed application visibility. Our telemetry applications include VM Tracer, which provides visibility down to the virtual machine level, Path Tracer, which detects errors in provisioned network paths, MapReduce Tracer, which monitors and optimizes the performance of Hadoop workloads, and Health Tracer, which monitors infrastructure resiliency. Our network visibility applications provide real-time insight into the status of the network. They include LANZ, which monitors latency,
Through the integration of DANZ features native to Arista switches with Big Switch’s monitoring software, we provide the DANZ Monitoring Fabric (DMF). DMF delivers network traffic analysis, data analytics and DANZ 2017, a set of features previously only available in add-oncontextual insights to enterprises looking for network visibility devices, which provides advanced traffic monitoring with flow analysis and timestamps, plus the ability to perform tap aggregation for reporting and analysis.wide observability.
Security
Macro-Segmentation Services (MSS™(MSSTM) is one of the services enabled via CloudVision. Since CloudVision maintains a network-wide database of all statestates within the network, as well as direct integration with hypervisor resources like VMware vSphere and NSX. It is aware of every workload that is within the network and it learns in real time about new devices or workloads that are added or removed from the network, or moved across ports or servers. Macro-segmentationNSX, Macro-Segmentation extends the concept of fine-grained inter-hypervisor security to cloud networks by enabling dynamic security and services for physical to virtual workloads. Macro-segmentation securityworkloads, and is a complement to fine-grained security delivered via micro-segmentationMicro-Segmentation that is already implemented in the virtual switch of the physical host on which a VM is running.
Lower Total Cost of Ownership
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Our cloud networking platform offers architectural and system advantages that provide our customers with cost-effective and highly available cloud networking solutions. OurWe believe our programmable, scalable leaf-spine architectures, combined with industry-leading applications, significantly reduce networking costs when compared to legacy network designs, enabling faster time to service and improved availability. Our automation tools reduce the operational costs of provisioning, managing and monitoring a data center network and speed up service delivery. Our visibility tools provide high levels of visibility into complex network environments without the need for additional data collection equipment. As a result, this lowers operational costs because fewer network engineers are needed to operate large networks.
Cognitive Cloud Networking for the Campus Workspace
Our Market OpportunityCognitive Cloud Networking solutions for the next-generation campus are based on three principles:
Universal Cloud Network - We compete primarilyoffer our Universal Cloud Network as an alternative to brittle, proprietary solutions from legacy vendors. Our Universal Cloud Network is an open, standards-based design focusing on software-driven control principles. Our collapsed Spline™ approach consolidates traditional campus core and aggregation layers into a simple single tier with high availability.
Cognitive Management Plane - There is a void in management plane consistency and a need for data-driven analytics in the campus, as in the data center switching market for 10 Gigabit Ethernet and above, excluding blade switches. We also compete in the enterprise campus market for 1 Gigabit Ethernet switching and above and cloud-managed wireless networking.
center. We believe that cloud computing represents a fundamental shift from traditional legacy data centerscommon model can be applied across both footprints, saving customers operational costs. The Cognitive Management Plane (CMP) is a data-driven repository for the automated actions across network analytics.
Securing The Campus - Securing the Campus spline requires a holistic approach to network segmentation, device compliance and that cloud networking is the fastest growing segment within the data center switching market. As organizations of all sizes are adopting cloud architectures, spending on cloudauditing, as well as service integration with our security partners. We deliver these capabilities through EOS, DMF, Awake Security, and next-generation data centers has increased rapidly over the last several years, while traditional legacy IT spending has been growing more slowly. Our 7150, 7050, 7250, 7300 and 7500 Series platforms are now listed on the U. S. Department of Defense Approved Products Lists Integrated Tracking System by the Defense Information Systems Agency.
Our Competitive Strengths
We believe the following strengths will allow us to maintain and extend our technology leadership position in cognitive cloud networking and next-generation data center and campus workspace Ethernet products:
•Purpose-Built Cloud Networking Platform. We have developed a highly scalable cloud networking platform that uses software to address the needs of large-scale internet companies, cloud service providers, and large enterprises including financial services organizations, government agencies and media and entertainment companies, including virtualization, big data and low-latency applications. As a result, our cloud networking platform does not have the inherent limitations of legacy network architectures.
•Broad and Differentiated Portfolio. Using multiple merchant silicon architectures, we deliver switches, and routerscapable of routing, with industry-leading capacity, low latency, port density and power efficiency, and have innovated in areas such as deep packet buffers, embedded opticshighly available modular hardware, and reversible cooling.cooling options. Our broad portfolio has allowed us to offer customers products that best match their specific requirements.
•Single Binary Image Software. The single binary image of EOS software allows us to maintain feature consistency across our entire product portfolio and enables us to introduce new software innovations into the market that become available to our entire installed base without a “forklift upgrade” (i.e., a broad upgrade of the data center infrastructure).
•Rapid Development of New Features and Applications. Our highly modular EOS software has allowed us to rapidly deliver new features and applications while preserving the structural integrity and quality of our network operating system. We believe our ability to deliver new features and capabilities more
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quickly than legacy switch/router operators provides us with a strategic advantage given that the requirements in cloud and next-generation data center networking continue to evolve rapidly.
•Deep Understanding of Customer Requirements. We have developed close working relationships with many of our largest customers that provide us with insights about their needs and future requirements. This has allowed us to develop and deliver products to market that meet customer demands and expectations as well as to rapidly grow sales to existing customers.
•Strong Management and Engineering Team with Significant Data Center Networking Expertise. Our management and engineering team consists of networking veterans with extensive data center and campus networking expertise. Our President and Chief Executive Officer, Jayshree Ullal, with 30+has over 30 years of networking expertise from silicon to systems companies.Andy Bechtolsheim, our Founder and Chief Development Officer, was previously a Founderfounder and chief system architect at Sun Microsystems.Kenneth Duda, our Founder and Chief Technology Officer, led the software development effort of EOS.
•Significant Technology Lead. We believe that our networking technology represents a fundamental advance in networking software. Our EOS software is state-driven and the result of more than 1,000 man-years of research and development investment over a ten-year period with 10+ million lines of code as a key cloud networking software stack.
stack that is state-driven and a result of tremendous research and development efforts.Our Products and Technology
The core of our cloud networking platform is our Extensible Operating System, or EOS which runs on top of standard Linux and offers programmability at all layers of the stack. All of our 10/25/40/50/100 Gigabit Ethernet switching and routing platforms run on our EOS software.
EOS is based on a new and innovative architecture that is highly modular and consists of more than 100 separate processes that we call agents, each one handling specific protocol processing, device driver or system management functions. Each agent runs in user space as a separate Linux process and is completely protected and isolated from all other agents.
We are constantly investing in our core infrastructure to provide the capabilities required for building modern cloud networks and enhancing scalability. New requirements for use in cloud and service provider networks and hybrid cloud deployments in enterprises require on-going upgrades and extensions to our statestate- oriented architecture.
EOS Attributes
The modular and programmable architecture of EOS enables us to offer a set of attributes, capabilities and features that are essential for cloud networking and next-generation data centers.
High Availability
EOS is self-healing in the sense that individual processes can be restarted without impacting application traffic. This architectural design principle supports self-healing resiliency in our software, easier software maintenance and module independence, higher software quality overall, and faster time-to-market for new features that customers require.
Programmable at All Layers
EOS is programmable at all layers from the Linux kernel to switch configuration, provisioning, automation and detailed monitoring of the network.Public cloud providers have leveraged tools such as the
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EOS Software Development Kit (“SDK”) and eAPI to implement fully customized infrastructure automation solutions.
Workflow Visibility
Through EOS, we have developed a wide range of applications available to our customers for purchase as additional licenses that enable enhanced network monitoring and visibility without requiring additional external monitoring devices.This includes (i) DataANalyZer (DANZ), which provides access to raw network data for analysis by security, troubleshooting and performance management tools, (ii) Latency/loss ANalyZer (LANZ), which provides access to internal network performance loads and packet loss and latency occurring at the microsecond level, (iii) Network Telemetry, which provides network state information including correlations with the dynamic state of the systems operating on the network such as Hypervisors and, distributed job controls, and (iv) Network Tracers, which provide active integration and diagnostics for various workload conditions dependent upon network performance.
Network Automation
EOS supports Puppet, Chef and Ansible, which enablesenable automatic network configuration in the same manner as servers and storage. In addition, EOS provides tools that greatly reduce network operational costs. Another major component of network automation is Cloud Vision.
Cognitive Campus Switching and rollback;
Our customers typically deploy leaf-spine network topologies consisting of leafadjacent products include our Cognitive Campus switching products such as our 720XP fixed PoE switches, or top-of-rack switches, located in the server rack connected with uplinks to multiple load-sharing spine750 modular PoE switches and routers that provide the backbone. Our leaf-spine network designs scale up to more than 300,000 physical servers and millions of virtual machines using Equal Cost Multiple Path, or ECMP, to load balance Layer 3 network traffic across multiple spine7300X3 spline switches, and routers. With Multi-Chassis Link Aggregation, or MLAG, we can build an active-active Layer 2 network that can connect more than 25,000 physical servers. Our leaf-spine network designs have been widely deployed and provide predictable network bandwidth and latency. A key advantage of predictable network performance is that it eliminates the need to optimize the network for specific applications, which means a single network design works equallyas well for all applications.
Cognitive WiFi
Networking Software and Services
CloudVision
CloudVision is our network management plane solution for workload orchestration and workflow automation, which delivers a turnkey solution for cloud networking.CloudVision’s abstraction of the physical network to a broader, network-wide perspective provides a simplified approach for consistent network operations across network domains, including data center, campus wired and wireless, routing interconnect, and multi-cloud networks.
CloudVision highlights include: Centralized representation of distributed network state, allowing for a single point of integration and network-wide visibility and analytics; Controller-agnostic support for physical
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and virtual workload orchestration through open APIs; Turn-key automation for zero touch provisioning, configuration management and network-wide upgrades and rollback; Compliance dashboard for security, audit and patch management; Cognitive AI/ML for dynamic insights and recommendations, built on a modern approach of real-time streaming for telemetry and as a replacement for legacy polling per device; Granular visibility and historical troubleshooting with predictive insights across the unified edge wired and wireless networks, including IoTvision, and finally Multi-domain segmentation for the zero trust enterprise, enabling macro-segmentation services (MSS®) protects networks against rogue APs, honeypotsfor an open and implements device classificationscalable approach for network policy management and with dynamic integrations into security management systems from Arista’s security ecosystem partners.
DANZ Monitoring Fabric (DMF)
DANZ Monitoring Fabric (DMF) is a next-generation network packet broker (NPB) architected for pervasive, organization-wide visibility and security, delivering multi-tenant monitoring-as-a-service. DMF enables IT operators to determine authorized client devices connecting to unauthorized APs. Additional WIPS scanning is accomplished viapervasively monitor all user, device/IoT and application traffic (north-south and east-west) by gaining complete visibility into physical, virtual and container environments. Deep hop-by-hop visibility, predictive analytics and scale-out packet capture — integrated through a dedicated third radio which can also perform varioussingle dashboard — enable simplified network performance monitoring (NPM) and health diagnostics. SecMon workflows for real-time and historical context, delivering a one-stop visibility solution for on-premise data centers, enterprise campus/branch and 4G/5G mobile networks.
Awake Security
Awake Security is an advanced network detection and response (NDR) solution that delivers answers, not alerts. By combining artificial intelligence with human expertise, Awake Security autonomously hunts for both insider and external attacker behaviors, while providing triage, digital forensics and incident response across the new network — campus workspace, data center, Internet of Things (IoT)/operational technology (OT) and cloud networks.
The AP can simulateAwake AI-driven Security Platform deeply analyzes billions of network communications to autonomously discover, profile and classify every device, user and application across any network. Using a client device—associationmulti-dimensional ensemble machine learning approach, Awake Security then models complex adversarial behaviors and authentication instrumenting identitydetects threats by connecting the dots across entities, time, protocols and access (AAAattack stages.
CloudEOS
CloudEOS™ is Arista’s multi-cloud and DHCP/DNS) latencies, connectivity tocloud-native networking solution enabling a highly secure and reliable networking experience with consistent segmentation, telemetry, provisioning and troubleshooting for the upstream network and voice calls to calculate MOS score and network throughput. These automated testsentire enterprise. It can be pre-scheduled without administrator intervention ensuring business ready WiFi.deployed across the enterprise edge, WAN, campus workspace, data center, on-premises Kubernetes clusters, and multiple public and private clouds. CloudEOS provides multi-cloud connectivity across the entire enterprise cloud environment with high-performance virtual and container-based instances of EOS software that simplify network operations and integrate with declarative cloud provisioning toolchains like Terraform, Ansible, and other popular CloudOps and DevOps tools.
CloudEOS is designed for consumption on Amazon AWS, Microsoft Azure, and Google public clouds via their marketplace and service catalogs, and it is also available as a cloud-native instance for deployment in Kubernetes clusters. With CloudEOS and CloudVision, WiFi applications fuses customers can integrate their cloud network deployments with the elasticity and automation of the public cloud, private cloud and cloud native platforms.
Arista access points with cloud networking spines and splines for a seamless topology view.
We have designed our customer support offerings, Arista A-Care Services, to provide our customers with high levels of support. Our global team of support engineers engages directly with client IT teams and is available at all times over e-mail, by phone or through our website.
We offer multiple service options that allow our customers to select the product replacement service level that best meets their needs. We stock spare parts in over 125183 locations around the world through our third-party logistics suppliers. All of our service options include unlimited access to bug-fixes, new feature-releases,new-feature-releases, online case management and our community forums.
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Sales and Marketing
We market and sell our products through our direct sales force and in partnership with our channel partners, including distributors, value-added resellers, systems integrators and OEM partners. We also sell in conjunction with various technology partners. To facilitate channel coordination and increase productivity, we have created a partner program, the Arista Partner Program, to engage partners who provide value-added services and extend our reach into the marketplace. Authorized training partners perform technical training of our channel partners and end customers. Our partners commonly receive an order from an end customer prior to placing an order with us, and we confirm the identification of the end customer prior to accepting such orders. Our partners generally do not stock inventory received from us.
Our sales organization is supported by systems engineers with deep technical expertise and responsibility for pre-sales technical support and solutions engineering for our end customers, systems integrators, original equipment manufacturers, or OEMs, and channel partners. A pool of shared channel sales and marketing representatives also supports these teams. Each sales team is responsible for a geographical territory, has responsibility for a number of major direct end-customer accounts or has assigned accounts in a specific vertical market. We have field sales teams operating in approximately 86 countries.
Our marketing activities consist primarily of technology conferences, web marketing, trade shows, product demonstrations, seminars and events, public relations, analyst relations, demand generation and direct marketing to build our brand, increase end-customer awareness, communicate our product advantages and generate qualified leads for our field sales force and channel partners.
Seasonality
Our rapid historical growth may have reduced the impact of seasonal or cyclical factors that might have influenced our business to date. As our increasing size causes our growth rate to slow, seasonal or cyclical variations in our operations may become more pronounced over time and may materially affect our business, financial condition, results of operations and prospects. We operate on a December 31st year end and have typically experienced higher sequential product revenue growth in the fourth quarter, followed by flat-to-declining sequential growth in the first quarter of the following year. We believe that this seasonality results from a number of factors, including the procurement, budgeting and deployment cycles of many of our end customers.
Research and Development
We believe our future success depends on our ability to develop new products and features that address the needs of our end customers. Our in-house engineering personnel are responsible for the development, quality, documentation, support and release of our products. We plan to continue to invest significantly in resources to conduct our research and development efforts.
Manufacturing
We subcontract the manufacturing of all of our products to various contract manufacturers. Our primary manufacturing partners are Jabil Circuit and Sanmina Corporation and Foxconn. Corporation.This approach allows us to reduce our costs, manufacturing overhead and inventory position and allows us to adjust more quickly to changing end-customer demand. We require all of our manufacturing locations to be ISO-9001 certified. OurWe have four direct fulfillment facilities worldwide to hold finished goods inventory, perform product transformations, and install our EOS software is installed on our products at one of three direct fulfillment facilities.to ship to customers and partners.
Our contract manufacturing partners procure the majority of the components needed to build our products and assemble our products according to our design specifications. This allows us to leverage the purchasing power of our contract manufacturing partners. We retain complete control over the billbills of material, test procedures and quality assurance programs. Our on-site personnel work closely with our partners and review on an ongoing basis forecasts, inventory levels, processes, capacity, yields and overall quality. Our contract manufacturing partners procure components and assemble our products based on our demand forecasts. These forecasts represent our estimates of future demand for our products based upon historical trends and analyses from our sales and product management functions as adjusted for overall market conditions. We update these forecasts monthly.
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Our products rely on key components, including merchant silicon, integrated circuit components and power supplies purchased from a limited number of suppliers, including certain sole source providers. We also expect to see increased consolidation among our component suppliers. Generally, neither we nor our contract manufacturers nor we have a written agreement with these component providers to guarantee the supply of the key components used in our products, nor do we have exclusive rights to such key components. components, and our suppliers could suffer shortages, delay shipments, prioritize shipments to other vendors, increase prices or cease manufacturing such products or selling them to us at any time. The supply of components may also be adversely affected by geopolitical conditions such as international trade wars like the U.S. trade war with China and the impact of public health epidemics like the coronavirus currently spreading around the world.
Our product development efforts also depend upon continued collaboration with our key suppliers, including our merchant silicon vendors such as Broadcom and Intel. As we develop our product roadmap and continue to expand our relationships with these and other merchant silicon vendors, it is critical that we work in tandem with our key merchant silicon vendors to ensure that their silicon includes improved features and that our products take advantage of such improved features. This enables us to focus our research and development resources on software core competencies and to leverage the investments made by merchant silicon vendors to achieve cost-effective solutions.
Once the completed products are manufactured and tested, our contract manufacturing partners ship them to various theatre direct fulfillment facilities in the United States, the Netherlands and Singapore for final configuration, quality controlquality-control inspection and shipment to our distribution partners and end customers. After the products are shipped to our end customers, our products are installed by the end customers or by third-party service providers such as system integrators or value addedvalue-added resellers on their behalf.
Competition
The markets in which we compete are highly competitive and characterized by rapidly changingrapidly-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.
The data center and campus networking markets have been historically dominated by Cisco, Systems (“Cisco”), with competition also coming from other large network equipment and system vendors, including Extreme Networks, Dell/EMC, Hewlett Packard Enterprise and Juniper Networks and Mist Systems.Networks. Most of our competitors and some strategic alliance partners have made acquisitions and/or have entered into or extended partnerships or other strategic relationships to offer more comprehensive product lines, including cloud networking solutions.For example, in the last few years alone, Broadcom acquired Brocade Communications Systems, Extreme Networks purchased certain data center networking assets from Broadcom/Brocade and Avaya as well as Aerohive Networks, Dell acquired Force10 and EMC, IBM acquired Blade Network Technology, Hewlett Packard Enterprise acquired Aruba Networks and Juniper Networks acquired Contrail Systems, and Cisco acquired Insieme Networks. Mist Systems.
We also face competition from other companies and new market entrants, including “whitebox” switch vendors as well as current technology partners and end customers who may acquire or develop network switches and cloud service solutions for internal use and/or to broaden their portfolio of products to market and sell to customers. Furthermore,Some of these competitors are developing networking products based on off-the-shelf or commoditized hardware technology, or “white box” hardware, particularly where an end customer’s network strategy seeks to emphasize deployment of such product offerings or adopt a disaggregated approach to the procurement of hardware and software. End customers may also increase their adoption of networking solutions based upon open source network operating systems that may be provided for free and used either on “white box” or proprietary hardware. The entrance of new competitors into our markets or the increased adoption of these new technology solutions or consumption models may cause downward pricing pressures, result in lost sales or otherwise have a material adverse effect on our business, prospects, financial condition and operating results.
In the network detection and response (NDR) market, Awake Security competes with other network security vendors including Cisco, DarkTrace, and ExtraHop. Lastly, in the network packet broker (NPB)
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market, Arista DANZ Monitoring Fabric competes with Gigamon, IXIA, and other network monitoring software providers.
Our relationships with our strategic alliance partners or suppliers may also shift as industry dynamics changes.change. If strategic alliance partners acquire or develop competitive products or services, our relationship with those partners may be adversely impacted, which could lead to more variability to our results of operations and impact the pricing of our solutions.
The principal competitive factors applicable to our products include:
•breadth of product offerings and features;
•reliability and product quality;
•ease of use;
•pricing;
•total cost of ownership, including automation, monitoring and integration costs;
•performance and scale;
•programmability and extensibility;
•interoperability with other products;
•ability to be bundled with other vendor offerings; and
•quality of service, support and fulfillment.
We believe our products compete favorably with respect to these factors. Our EOS software offers high reliability, integrates with existing network protocols and is open and programmable. We believe the combination of EOS, a set of network applications and our 1/2.5/5/10/25/40/50/100100/400 Gigabit Ethernet platforms make our offering highly competitive for both cloud and enterprise data centers. However, many of our competitors have greater name recognition, longer operating histories, larger sales and marketing budgets and resources, broader distribution and established relationships with channel partners and end customers, greater access to larger end-customer bases, greater end-customer support resources, greater manufacturing resources, the ability to leverage their sales efforts across a broader portfolio of products, the ability to leverage purchasing power when purchasing subcomponents, the ability to bundle competitive offerings with other products and services, the ability to develop their own silicon chips, the ability to set more aggressive pricing policies, lower labor and development costs, greater resources to make acquisitions, larger intellectual property portfolios and substantially greater financial, technical, research and development or other resources.
Intellectual Property
Our success and ability to compete depend substantially upon our core technology and intellectual property. We rely on patent, trademark and copyright laws, trade secret protection and confidentiality agreements with our employees, end customers, resellers, systems integrators and others to protect our intellectual property rights. We
file U.S and foreign patent applications to protect our intellectual property and believe that the duration of our issued patents is adequate relative to the expected lives of our products. Patents generally have a duration of twenty years from filing. The remaining duration on the individual patents in our patent portfolio varies.
We cannot assure you that any of our patent applications will result in the issuance of a patent or whether the examination process will result in patents of valuable breadth or applicability. In addition, any patents that may be issued may be contested, circumvented, found unenforceable or invalidated, and we may not be able to prevent third parties from infringing them. We also license software from third parties for integration into our products, including open source software and other software available on commercially reasonablecommercially-reasonable terms. We also own a number of trademarks in the U.S. and other jurisdictions, including Arista, EOS, CloudVision,
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CloudStream, CVP, CVX, Health Tracer, MapReduce Tracer, Path Tracer, MXP, MSS, RAIL, Score, SPLINE, SuperSpine, SSU, FlexRoute, NetRollBack, NetDB, OSFP, AlgoMatch, Macro-Segmentation and Macro-Segmentation Service.
We control access to and use of our software, technology and other proprietary information through internal and external controls, including contractual protections with employees, contractors, end customers and partners. Our software is protected by U.S. and international copyright, patent and trade secret laws. Despite our efforts to protect our software, technology and other proprietary information, unauthorized parties may still copy or otherwise obtain and use our software, technology and other proprietary information. In addition, we intend to expand our international operations, and effective patent, copyright, trademark and trade secret protection may not be available or may be limited in foreign countries.
Our industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual property rights. If we become more successful, we believe that competitors will be more likely to try to develop products that are similar to ours and that may infringe our proprietary rights. It may also be more likely that competitors or other third parties will claim that our products infringe their proprietary rights. In particular, large and established companies in our industry have extensive patent portfolios and are regularly involved in both offensive and defensive litigation. From time to time, third parties, including certain of these large companies and non-practicing entities, may assert patent, copyright, trademark and other intellectual property rights against us, our channel partners or our end customers, whom our standard license and other agreements obligate us to indemnify against such claims. Please see “Legal Proceedings” included in Part I, Item 3 of this Annual Report on Form 10-K, for a description of this litigation.
Successful claims of infringement by a third party, if any, could prevent us from distributing certain products or performing certain services, require us to expend time and money to develop non-infringing solutions or force us to pay substantial damages, royalties or other fees. We cannot assure you that we do not currently infringe, or that we will not in the future infringe, upon any third-party patents or other proprietary rights.
At Arista, we seek to maintain an environment that is open, diverse and inclusive, and where our people feel valued, included and accountable. One of Arista’s key principles is always doing the right thing for our employees. We are committed to maintaining the highest level of professional and ethical standards in the conduct of our business around the world. As of December 31, 2018,2020, we employed approximately 2,3002613 full-time employees.employees worldwide. None of our employees areis represented by unions. We consider our relationship with our employees to be good and have not experienced significant interruptions of operations due to labor disagreements.
We were incorporatedseek to maintain an environment that is open, diverse and inclusive, and where our employees feel valued.We believe that diverse and inclusive teams enhance individual and company performance and help us attract and retain the best talent available.We strive to build an inclusive culture that encourages, supports and celebrates the diverse voices of our employees.As part of the Arista way, we believe in treating peers with respect, mentoring individuals and developing teams for overall success.
We are proud to be an S&P 500 company with both a female CEO and CFO.We also actively promote the Statehiring of Californiafemale engineers by supporting periodic technology sessions for female engineers.In addition, we support under-represented employee affinity organizations and actively recruit from under-represented universities and professional societies.
Arista affirms the principle of equal employment opportunity without regard to any protected characteristic, including but not limited to race, religion, national origin, color, gender, age, disability, pregnancy, marital status, ancestry, military status or sexual orientation.We practice and promote such policies in all locations as Arastra, Inc.appropriate under applicable law.We affirm this principle of freedom from discrimination in October 2004. all aspects of the employment relationship from recruitment and hiring, through performance evaluations,
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compensation and promotions.At Arista, we believe that all employees should be treated with dignity and respect.
Health and Safety
We reincorporatedare committed to protecting the health and safety of our employees, visitors, and the public. Our policy is to maintain our facilities and run our business operations in a manner that does not jeopardize the Stateoccupational health and safety of Nevadaemployees.
During the COVID-19 pandemic, Arista asked its employees to work from home with limited exceptions.Essential workers have been given to access to our facilities as may be permitted under applicable laws after instituting additional health and safety measures to reduce the risk of COVID-19.We work to provide safe working environments in March 2008,our operations.
Compensation and we changedBenefits
Arista provides competitive and comprehensive benefit packages that are designed to help employees make the best decisions for themselves, their family and their lifestyle.Our compensation committee provides oversight of our namecompensation policies, plans, benefit programs and overall compensation philosophy.
Along with Arista’s traditional healthcare benefits, Arista has created a detailed injury and illness prevention program to better protect employees from occupational risks of injury or illness.Arista Networks, Inc.periodically hosts wellness days, whose purpose is to raise awareness on health issues, increase education on preventive medicine and available services and shift employee behavior through interactive activities and live presentations.We also maintain a community engagement program, which provides opportunities for our employees to engage in October 2008. We reincorporated in the State of Delaware in March 2014.
community service.
Available Information
Our website is located at www.arista.com and our investor relations website is located at investors.arista.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available free of charge on the Investors portion of our web siteweb-site as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (SEC). The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.
Webcasts of our earnings calls and certain events we participate in or host with members of the investment community are on our investor relations website. Additionally, we announce investor information, including news and commentary about our business and financial performance, SEC filings, notices of investor events, and our press and earnings releases, on our investor relations website. Investors and others can receive notifications of new information posted on our investor relations website in real time by signing up for email alerts and RSS feeds. Further corporate governance information, including our corporate governance guidelines, board committee charters, and code of conduct, is also available on our investor relations website under the heading “Governance.” The contents of our websites, or information that can be accessed through our websites, are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC, and any references to our websites are intended to be inactive textual references only.
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Item 1A. Risk Factors
You should consider carefully the risks and uncertainties described below, together with all of the other information in this Annual Report on Form 10-K, which could materially affect our business, financial condition, results of operations and prospects. The risks described below are not the only risks facing us. Risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially affect our business, financial condition, results of operations and prospects.
Risk Factors Summary
Our business is subject to numerous risks and uncertainties, including those highlighted in Part I, Item 1A titled “Risk Factors.” These risks include, but are not limited to, the following:
Risks Related to Our Business and Our Industry
•the networking market is rapidly evolving;
•failure to successfully pursue new products and services and expand into adjacent markets could adversely affect our business;
•our revenue and revenue growth may decline;
•our results of operations have experienced rapid growth,may vary significantly from period to period;
•our gross margins vary and may be adversely affected;
•shipment delays could cause revenue to fall;
•adverse economic conditions and reduced information technology and network infrastructure spending may adversely affect our business;
•we face intense competition and industry consolidation;
•we are subject to risks associated with international sales and operations;
•we face risks associated with the acquisition and integration of complementary companies, products or technologies;
•seasonal fluctuations impact revenue;
•fluctuations in currency exchange rates could adversely affect our business;
•failure to raise any needed capital on favorable terms could harm our business.
Risks Related to Customers and Sales
•if we do not appropriately manage any future growth or are unable to improveattract new large customers or sell additional products and services to our existing customers, our revenue growth will be adversely affected;
•large purchases by a limited number of customers represent a substantial portion of our revenue;
•if we are unable to increase market awareness of our products, our revenue may not continue to grow or may decline;
•some large customers require more favorable terms;
•sales of our switches generate most of our product revenue;
•sales prices of our products and services may decrease;
•sales cycle can be long and unpredictable;
•inability to offer high quality support and services could adversely affect our business;
•declines in maintenance renewals by customers could harm our business;
•indemnification provisions under sales contracts could expose us to losses;
•we rely on distributors, systems integrations and processes,resellers to sell our products;
•sales to government entities are subject to a number of risks and challenges;
•we are exposed to credit risk of channel partners and customers.
Risks Related to Products and Services
•product quality problems, defects, errors or vulnerabilities could harm our business;
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•failure to anticipate technological shifts could harm our business;
•our products must interoperate with operating systems, software and hardware developed by others.
Risks Related to Supply Chain and Manufacturing
•managing the supply of our products and product components is complex;
•some key components in our products come from sole or limited sources of supply which results in risks of supply shortages and supply changes;
•we depend on third-party manufacturers to build our products;
•future sales forecasts may be materially inaccurate which could result incorrect levels of inventory.
Risks Related to Intellectual Property and Other Proprietary Rights
•assertions by third parties of intellectual property infringement could harm our business;
•failure to protect our intellectual property rights could harm our competitive position;
•we rely on the availability of licenses to third party software and other intellectual property;
•failure to comply with open source software could restrict our ability to sell our products;
•risk that our competitors could develop products that are similar to or better than ours because we provide access to our software and selected source code to certain partners, which creates additional risks.
Risks Related to Litigation
•we may become involved in litigation that may materially adversely affect us.
Risks Related to Cybersecurity and Data Privacy
•defects, errors or vulnerabilities in our security network products or the failure of our products to detect security breaches could harm our business;
•breaches of our cybersecurity systems or other security breaches could harm our business and our products.
Risks Related to Accounting, Compliance, Regulation and Tax
•failure to maintain effective internal control over financial reporting could adversely affect the accuracy and timing of our financial reporting;
•if our critical accounting policies are based on incorrect assumptions, our results of operations could fall below analyst and investor expectations and result in a decline in the market price of our common stock;
•enhanced U.S. tax, tariff, import/export restrictions or other trade barriers may negatively affect our business;
•changes in our effective tax rate or new tax laws could adversely affect our results;
•failure to comply with government laws and regulations could harm our business;
•we are subject to governmental export and import controls that could impair our ability to compete in international markets or subject us to liability for violations.
Risks Related to Ownership of Our Common Stock
•the trading price of our common stock is volatile and the value of your investment may decline;
•any reduction or discontinuance of our stock repurchase program could cause the market price of our common stock to decline;
•sales of substantial amounts of our common stock could reduce the market price of our common stock;
•insiders have substantial control over us;
•our charter documents and Delaware law could discourage takeover attempts and lead to management entrenchment.
General Risks
•if we are unable to hire, retain and train personnel and senior management, our business could suffer;
•natural disasters, terrorism and other catastrophic events could harm our business;
•we have not paid dividends and do not intend to pay dividends for the foreseeable future.
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Risks Related to Our Business and Industry
The COVID-19 pandemic could materially adversely affect our business, financial condition, results of operations and prospects will be adversely affected.prospects.
As the COVID-19 pandemic continues, we have experienced and may continue to experience additional risks including:
•more manufacturing disruptions and supply shortages;
•longer lead-times for component parts incorporated into our products;
•reduced capacity and output at factories and factory closures;
•disruptions in logistics which impact the movement of components and finished products;
•overall increased demand for materials which could result in a limited supply of materials and components that are incorporated in our products;
•delays in product shipments and limits on our ability to provide in-person support services to customers;
•increased risk of future excess and obsolete inventory as we increase our inventory buffers of long lead time components to support longer term customer demand; and
•further increased lead times for our products.
The COVID-19 pandemic could limit our ability to add new customers and cause sales disruptions, order cancellations, longer upgrade cycles by customers for network equipment and overall lower demand for our products overand services.Customers may purchase products in advance of their internal demand which could result in lower purchases in subsequent quarters.We could face increased risk of customer defaults and delays in payment.
In addition, the last several years, whichCOVID-19 pandemic has placed a strain on our management, administrative, operationaladversely affected, and may continue to adversely affect, the global economy and financial infrastructure. Our employee headcount and number of end customers have increased, and we expect both to continue to grow over the next year. For example, between December 31, 2015 and December 31, 2018, our headcount grew from approximately 1,200 employees to approximately 2,300 employees, and our cumulative number of end customers grew from approximately 3,700 to over 5,500. As we have grown, we have had to manage an increasingly large and more complex array of internal systems and processes to scale with all aspects of our business, including our hardware and software development, contract manufacturing, purchasing, logistics, fulfillment and maintenance and support. Our success will depend in part upon our ability to manage our growth effectively. To do so, we must continue to increase the productivity of our existing employees and continue to hire, train and manage new employees as needed. To manage domestic and international growth of our operations and personnel, we will need to continue to improve our operational, financial and management controls and our reporting processes and procedures and implement more extensive and integrated financial and business information systems. We may not be able to successfully implement these or other improvements to our systems and processes in an efficient or timely manner, and we may discover deficiencies in their capabilities or effectiveness. We may experience difficulties in managing improvements to our systems and processes or in connection with third-party technology. In addition, our systems and processes may not prevent or detect all errors, omissions or fraud. Our failure to improve our systems and processes, or their failure to operate effectively and in the intended manner,markets, which may result in disruptionan extended economic slowdown or a global recession that could adversely impact our business.Due to the duration of the pandemic, the uncertainty around vaccination deployment with respect to the COVID-19 pandemic, the uncertainty around the impact of new strains of COVID-19 and uncertain timing of a global recovery, we are unable to predict the full impact of the COVID-19 pandemic on our currentbusiness operations and end-customer relationships, our inability to manage the growth of our business and our inability to accurately forecast our revenue, expenses and earnings and prevent certain losses.
financial performance.
The cloud networking market is rapidly evolving. If this market does not evolve as we anticipate or our target end customers do not adopt our cloud networking solutions, we may not be able to compete effectively, and our ability to generate revenue will suffer.
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A substantial portion of our business and revenue depends on the growth and evolution of the cloud networking market. The market demand for cloud networking solutions has increased in recent years as end customers have deployed larger, more sophisticated networks and have increased the use of virtualization and cloud computing. The continued growth of this market will be dependent upon many factors including but not limited to the adoption of and demand for our end customers’ products and services, the expansion, evolution and build out of our end customers’ networks, the capacity utilization of existing network infrastructures, changes in the technological requirements for the products and services to be deployed in these networks, the amount and mix of capital spending by our end customers, the development of network switches and cloud service solutions by our large end customers for internal use, the financial performance and prospects of our end customers, the availability of capital resources to our end customers, changes in government regulation that could impact cloud networking business models including those regulations related to cyber security,cybersecurity, privacy, data protection and net neutrality, our ability to provide cloud networking solutions that address the needs of end customers more effectively and economically than those of other competitors or existing technologies and general economic conditions.conditions, including the impact of the COVID-19 pandemic.
If the cloud networking solutions market does not develop in the way we anticipate or otherwise experiences a slow-down, if our solutions do not offer benefits compared to competing networking products or if end customers do not recognize the benefits that our solutions provide, then our business, financial condition, results of operations and prospects could be materially adversely affected.
We pursue new product and service offerings and technology initiatives from time to time,expand into adjacent markets, and if we fail to successfully carry out these initiatives, our business, financial condition, or results of operations could be adversely impacted.
Additionally, from time to time, we invest in expansion into adjacent markets, including the campus switching, and WiFi networking and network security markets. Although we believe these solutions are complementary to our current offerings, we have less experience and a more limited operating history in these markets, and our efforts in this area may not be successful. Expanding our services in existing and new markets and increasing the depth and breadth of our presence imposes significant burdens on our marketing, compliance, and other administrative and managerial resources. Our plan to expand and deepen our market share in our existing markets and possibly expand into additional markets is subject to a variety of risks and challenges. Our success in these new markets depends on a variety of factors, including the following:
Additionally, future market share gains may take longer than planned and cause us to incur significant costs. If we are unable to attract new large end customers or to sell additional products and services to our existing end customers, our revenue growth will be adversely affected and our revenue could decrease.Difficulties in any of our new product development efforts or our efforts to enter adjacent markets could adversely affect our operating results and financial condition.
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Our revenue and our ability to generate revenue will suffer.growth rate may decline.
Our revenue growth rate in recent periods may not be indicative of our future performance.
Our results of operations are likely tomay vary significantly from period to period and be unpredictable and if we fail to meet the expectations of analysts or investors or our previously issued financial guidance, or if any forward-looking financial guidance does not meet the expectation of analysts or investors, the market price of our common stock could decline substantially.
Our results of operations have historically varied from period to period, and we expect that this trend will continue. As a result, you should not rely upon our past financial results for any period as indicators of future performance. Our results of operations in any given period can be influenced by a number of factors, many of which are outside of our control and may be difficult to predict, including:
•the disruption caused by COVID-19 and the government restrictions in response to the pandemic;
•our inability to fulfill our end customers’ orders due to the availability of inventory, supply chain delays, access to key commodities or technologies or events that impact our manufacturers or their suppliers;
•our ability to increase sales to existing customers and attract new end customers, including large end customers;
•the budgeting, sales and implementation cycles, purchasing practices and buying patterns of end customers, including large end customers who may receive lower pricing terms due to volume discounts and who may or may not make large bulk purchases in certain quarters;quarters or who may elect to re-assign allocations to multiple vendors based upon specific network roles or projects;
•changes in the growth rate of existing or new customers, including large end customers and service providers, changes in end-customer, geographicdistributor or product mix;
reseller requirements or market needs, and changes in growth rates of the networking market;
•the cost and potential outcomes of existing and future litigation, including the OptumSoft litigation matters;litigation;
•increased expenses resulting from the tariffs imposed by the U.S. on goods from other countries and tariffs imposed by other countries on U.S. goods, including the tariffs recently implemented and additional tariffs that have been proposed by the U.S. government on various imports from China;
•changes in our pricing policies, whether initiated by us or as a result of competition;
•the amount and timing of operating costs and capital expenditures related to the operation and expansion of our business;
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•difficulty forecasting, budgeting and planning due to limited visibility beyond the first two quarters into the spending plans of current or prospective customers;
•deferral, reduction or cancellation of orders from end customers, including in anticipation of new products or product enhancements announced by us or our competitors, or warranty returns;
•the inclusion of any acceptance provisions in our customer contracts or any delays in acceptance of those products;
•the actual or rumored timing and success of new product and service introductions by us or our competitors or any other change in the competitive landscape of our industry, including consolidation among our competitors or end customers;
•our ability to successfully expand our business domestically and internationally;
•our ability to increase the size and production of our sales or distribution channel, or any disruption in, or termination of, our sales or distribution channels, and/or termination of our relationship with important channel partners;channels;
•decisions by potential end customers to purchase our networking solutions from larger, more established vendors, white box vendors or their primary network equipment vendors;
•insolvency or credit difficulties confronting our end customers, which could adversely affect their ability to purchase or pay for our products and services, or confronting our key suppliers, including our sole source suppliers, which could disrupt our supply chain;
•seasonality or cyclical fluctuations in our markets;
•future accounting pronouncements or changes in our accounting policies;
•our overall effective tax rate, including impacts caused by any reorganization in our corporate structure, any changes in our valuation allowance for domestic deferred tax assets and any new legislation or regulatory developments, including the Tax Cuts and Jobs Act of 2017 (the “Tax Act”);
•increases or decreases in our expenses caused by fluctuations in foreign currency exchange rates, as an increasing portion of our expenses are incurred and paid in currencies other than the U.S. dollar;
•general economic conditions, both domestically and in foreign markets;markets, and disruptions in our business and the markets due to, among other things, health epidemics, natural disasters, terrorism and other catastrophic events;
•increases in cybersecurity threats, including security threats from state sponsors; and
•other risk factors described in this Annual Report on Form 10-K.
Any one of the factors above or the cumulative effect of several of the factors described above may result in significant fluctuations in our financial and other results of operations.operations and may cause the market price of our common stock to decline.In the past, we have failed to meet investor financial expectations and the market price of our common stock declined. This variability and unpredictability could result in our failure to meet our revenue, gross margins, results of operations or other expectations contained in any forward looking financial guidance we have issued or the expectations of securities analysts or investors for a particular period. If we fail to meet or exceed such guidance or expectations for these or any other reasons, the market price of our common stock could decline substantially, and we could face costly lawsuits, including securities class action suits.
We expect our gross margins to vary over time and to be adversely affected by numerous factors.
We expect our gross margins to vary over time and the gross margins we have achieved in recent years may not be sustainable and may be adversely affected in the future by numerous factors, including but not limited to
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changes in end-customer, geographic or product mix, increased price competition, introduction of new products and new business models including the sale and delivery of more software and subscription solutions, increases in material or component costs and production costs, entry into new markets or growth in lower margin markets, entry in markets with different pricing and cost structures, pricing discounts given to customers, costs associated with defending intellectual property infringement and other claims and the potential outcomes of such disputes, excess inventory and inventory holding charges, changes in shipment volume, the timing of revenue recognition and revenue deferrals, increased costs arising from tariffs, increased costs arising from epidemics, changes in distribution channels, increased warranty costs, and our ability to execute our operating plans.We determine our operating expenses largely on the basis of anticipated revenues and a high percentage of our expenses are fixed in the short and medium term. As a result, a failure or delay in generating or recognizing revenue could cause significant variations in our operating results and operating margin from quarter to quarter. Failure to sustain or improve our gross margins reduces our profitability and may have a material adverse effect on our business and stock price.
Interruptions or delays in shipments could cause our revenue for the applicable period to fall below expected levels.
We may be subject to supply chain delays, or end-customer buying patterns in which a substantial portion of sales orders and shipments may occur in the second half of each quarter. This places significant pressure on order review and processing, supply chain management, manufacturing, inventory and quality control management, shipping and trade compliance to ensure that we have properly forecasted supply purchasing, manufacturing capacity, inventory and quality compliance and logistics. A significant interruption in these critical functions, it could result in delayed order fulfillment, adversely affect our business, financial condition, results of operations and prospects and result in a decline in the market price of our common stock.
Adverse economic conditions or reduced information technology and network infrastructure spending may adversely affect our business, financial condition, results of operations and prospects.
Our business depends on the overall demand for information technology, network connectivity and access to data and applications. Weak domestic or global economic conditions, fear or anticipation of such conditions, international trade disputes, global pandemics, or a reduction in information technology and network infrastructure spending even if economic conditions improve, could adversely affect our business, financial condition, results of operations and prospects in a number of ways, including longer sales cycles, lower prices for our products and services, higher default rates among our distributors, and reduced unit sales and lower or no growth. For example, the global macroeconomic environment could be negatively affected by, among other things, the COVID-19 pandemic or other epidemics, instability in global economic markets resulting from fiscal and monetary stimulus measures to counteract the impact of the COVID-19 pandemic, increased U.S. trade tariffs and trade disputes between the U.S., China and other countries, instability in the global credit markets, the impact and uncertainty regarding global central bank monetary policy, including the instability in the geopolitical environment as a result of the withdrawal of the United Kingdom from the European Union ("EU"), political demonstrations, and foreign governmental debt concerns.Such challenges have caused, and are likely to continue to cause, uncertainty and instability in local economies and in global financial markets. In addition, the COVID-19 pandemic has caused business disruptions around the world and may result in customers delaying or canceling capital expenditures on information technology and network infrastructure, which may affect the overall demand for our products. Continuing or worsening economic instability could adversely affect spending for IT, network infrastructure, systems and tools. A longer period of economic uncertainty or a downturn may also significantly affect financing markets, the availability of capital and the terms and conditions of financing arrangements, including the overall cost of financing as well as the financial health or creditworthiness of our end customers. Circumstances may arise in which we need, or desire, to raise additional capital, and such capital may not be available on commercially reasonable terms, or at all.
We face intense competition, especially from larger, well-established companies and industry consolidation may lead to further increased competition, which may harm our business, financial condition, results of operations and prospects.
The markets in which we compete, including the markets for data center, campus networking and network security, are intensely competitive, and we expect competition to increase in the future from established competitors and new market entrants. This competition could result in increased pricing pressure, reduced profit margins,
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increased sales and marketing expenses and our failure to increase, or the loss of, market share, any of which would likely seriously harm our business, financial condition, results of operations and prospects.
The data center and campus networking markets have been historically dominated by Cisco, with competition also coming from other large network equipment and system vendors, including Extreme Networks, Dell/EMC, Hewlett Packard Enterprise, and Juniper Networks. Most of our competitors and some strategic alliance partners have made acquisitions and/or have entered into or extended partnerships or other strategic relationships to offer more comprehensive product lines, including cloud networking solutions and network security. For example, Broadcom acquired Brocade Communications Systems, Extreme Networks purchased certain data center networking assets from Broadcom/Brocade and Avaya, Dell acquired EMC, and Hewlett Packard Enterprise acquired Aruba Networks. This industry consolidation may lead to increased competition and may harm our business.Large system vendors are increasingly seeking to deliver top-to-bottom cloud networking solutions to end customers that combine cloud-focused hardware and software solutions to provide an alternative to our products.We expect this trend to continue as companies attempt to strengthen their market positions in an evolving industry and as companies are acquired or are unable to continue operations.Industry consolidation may result in stronger competitors that are better able to compete with us, and this could lead to more variability in our results of operations and could have a material adverse effect on our business, the pricing of our solutions, financial condition, results of operations and prospects.
We also face competition from other companies and new market entrants, including current technology partners, suppliers and end customers or other cloud service providers who may acquire or develop network switches and cloud service solutions for internal use and/or to broaden their portfolio of products to market and sell to customers.Some of these competitors are developing networking products based on off-the-shelf or commoditized hardware technology, or “white box” hardware, particularly where an end customer’s network strategy seeks to emphasize deployment of such product offerings or adopt a disaggregated approach to the procurement of hardware and software. End customers may also increase their adoption of networking solutions based upon open source network operating systems that may be provided for free and used either on “white box” or proprietary hardware. The entrance of new competitors into our markets or the increased adoption of these new technology solutions or consumption models may cause downward pricing pressures, result in lost sales or otherwise have a material adverse effect on our business, prospects, financial condition and operating results.
Our relationships with our strategic alliance partners or suppliers may also shift as industry dynamics changes. If strategic alliance partners acquire or develop competitive products or services, our relationship with those partners may be adversely impacted, which could lead to more variability to our results of operations and impact the pricing of our solutions.
Many of our existing and potential competitors enjoy substantial competitive advantages, such as greater name recognition and longer operating histories, larger sales and marketing budgets and resources, broader distribution and established relationships with channel partners and end customers, the ability to leverage their sales efforts across a broader portfolio of products, the ability to bundle competitive offerings with other products and services, the ability to develop their own silicon chips, the ability to set more aggressive pricing policies, lower labor and development costs, greater resources to make acquisitions, larger intellectual property portfolio, and substantially greater financial, technical, research and development or other resources.
In addition, large competitors may have more extensive relationships with and within existing and potential end customers that provide them with an advantage in competing for business with those end customers. For example, certain large competitors encourage end customers of their other products and services to adopt their data networking solutions through discounted bundled product packages. Our ability to compete will depend upon our ability to provide a better solution than our competitors at a more competitive price. We may be required to make substantial additional investments in research, development, marketing and sales in order to respond to competition, and we cannot assure you that these investments will achieve any returns for us or that we will be able to compete successfully in the future.
We also expect increased competition if our market continues to expand. As we continue to expand globally, we may see new competition in different geographic regions. In particular, we may experience price-focused competition from competitors in Asia, especially from China. As we expand into new markets, we will face competition not only from our existing competitors but also from other competitors, including existing companies
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with strong technological, marketing, and sales positions in those markets, as well as those with greater resources, including technical and engineering resources, than we do. Conditions in our market could change rapidly and significantly as a result of technological advancements or other factors.
We are subject to a number of risks associated with the expansion of our international sales and operations.
Our ability to grow our business and our future success will depend to a significant extent on our ability to expand our operations and customer base worldwide. Many of our customers, resellers, partners, suppliers and manufacturers operate around the world.Operating in a global marketplace, we are subject to risks associated with having an international reach and compliance and regulatory requirements.Our international sales and operations are subject to a number of risks, including the following:
•ability to establish necessary business relationships and to comply with local business requirements, including distributor and reseller relationships;
•greater difficulty in enforcing contracts and accounts receivable collection and longer collection periods and non-standard terms with customers related to payment, warranties or performance obligations;
•increased expenses incurred in establishing and maintaining our international operations;
•fluctuations in exchange rates between the U.S. dollar and foreign currencies where we do business;
•general economic and political conditions in these foreign markets;
•risks associated with U.S. and foreign legal requirements, including those relating to anti-corruption, anti-bribery, privacy, data protection and the importation, certification and localization of our products in foreign countries;
•risks associated with U.S. government trade restrictions, including those which may impose restrictions, including prohibitions, on the exportation, re-exportation, sale, shipment or other transfer of programming, technology, components, and/or services to foreign persons;
•greater risk of unexpected changes in regulatory practices, tariffs and tax laws and treaties, including the Tax Act, particularly since there has been a change in U.S. presidential administration;
•greater risk of unexpected changes in tariffs imposed by the U.S. and other countries;
•deterioration of political relations between the U.S. and China, Russia, Canada, Mexico, the United Kingdom and the EU, which could have a material adverse effect on our sales and operations in these countries;
•the uncertainty of protection for intellectual property rights in some countries; and
•heightened risk of unfair or corrupt business practices in certain geographies and of improper or fraudulent sales arrangements that may impact financial results and result in restatements of, or irregularities in, financial statements.
These and other factors could harm our ability to gain future international revenue and, consequently, materially affect our business, financial condition, results of operations and prospects. Expanding our existing international operations and entering into additional international markets will require significant management attention and financial commitments. Our failure to successfully manage our international operations and the associated risks effectively could limit our future growth or materially adversely affect our business, financial condition, results of operations and prospects.
We may invest in or acquire other businesses which could require significant management attention, disrupt our business, dilute stockholder value and adversely affect our business, financial condition, results of operations and prospects.
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As part of our business strategy, we may make investments in complementary companies, products or technologies which could involve licenses, additional channels of distribution, discount pricing or investments in or acquisitions of other companies. For example, we completed the acquisitions of Awake Security in October 2020 and Big Switch Networks in February 2020 which require management to focus efforts on integrating Awake Security and Big Switch Networks with the company. We may not be able to find suitable investment or acquisition candidates and we may not be able to complete such investments or acquisitions on favorable terms, if at all. If we do complete investments or acquisitions, we may not ultimately strengthen our competitive position or achieve our goals, and any investments or acquisitions we complete could be viewed negatively by our end customers, investors and securities analysts.Through acquisitions, we continue to expand into new markets and new market segments and we may experience challenges in entering into new market segments for which we have not previously manufactured and sold products, including facing exposure to new market risks, difficulty achieving expected business results due to a lack of experience in new markets, products or technologies or the initial dependence on unfamiliar distribution partners or vendors.
In addition, investments and acquisitions may result in unforeseen operating difficulties and expenditures. For example, if we are unsuccessful at integrating any acquisitions or retaining key talent from those acquisitions, or the technologies associated with such acquisitions, into our company, the business, financial condition, results of operations and prospects of the combined company could be adversely affected. We may have difficulty retaining the employees of any acquired business or the acquired technologies or research and development expectations may prove unsuccessful. Any integration process may require significant time and resources, and we may not be able to manage the process successfully. Acquisitions may also disrupt our ongoing business, divert our resources and require significant management attention that would otherwise be available for development of our business. We may not successfully evaluate or utilize the acquired technology or personnel or accurately forecast the financial effects of an acquisition transaction, including accounting charges. Any acquisition or investment could expose us to unknown liabilities. Moreover, we cannot assure you that the anticipated benefits of any acquisition or investment would be realized or that we would not be exposed to unknown liabilities. We may not be successful in retaining or expanding the customers and sales activities of any acquired business or in realizing the expected operational and cost efficiencies anticipated with the acquisition.We may have to pay cash, incur debt or issue equity securities to pay for any such investment or acquisition, each of which could adversely affect our financial condition or the market price of our common stock. The sale of equity or issuance of debt to finance any such acquisitions could result in dilution to our stockholders. The incurrence of indebtedness would result in increased fixed obligations and could also include covenants or other restrictions that would impede our ability to manage our operations. Moreover, if the investment or acquisition becomes impaired, we may be required to take an impairment charge, which could adversely affect our financial condition or the market price of our common stock.
Seasonality may cause fluctuations in our revenue and results of operations.
We operate on a December 31st year end and have typically experienced higher sequential product revenue growth in the fourth quarter, followed by flat to declining sequential growth in the first quarter of the following year. We believe that this seasonality results from a number of factors, including the procurement, budgeting and deployment cycles of many of our end customers. Our rapid historical growth may have reduced the impact of seasonal or cyclical factors that might have influenced our business to date. As our increasing size causes our growth rate to slow, seasonal or cyclical variations in our operations may become more pronounced over time and may materially affect our business, financial condition, results of operations and prospects.
We are exposed to fluctuations in currency exchange rates, which could adversely affect our business, financial condition, results of operations and prospects.
Our sales contracts are primarily denominated in U.S. dollars, and therefore, substantially all of our revenue is not subject to foreign currency risk. However, a strengthening U.S. dollar could increase the real cost of our products to our end customers outside of the U.S., which could adversely affect our business, financial condition, results of operations and prospects. In addition, a decrease in the value of the U.S. dollar relative to foreign currencies could increase our product and operating costs in foreign locations. Further, a portion of our operating expenses is incurred outside the U.S., is denominated in foreign currencies and is subject to fluctuations due to changes in foreign currency exchange rates. If we are not able to successfully hedge against the risks associated with the currency fluctuations, our business, financial condition, results of operations and prospects could be adversely affected.
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If we needed to raise additional capital to expand our operations, invest in new products or for other corporate purposes, our failure to do so on favorable terms could reduce our ability to compete and could harm our business, financial condition, results of operations and prospects.
We expect that our existing cash and cash equivalents, will be sufficient to meet our anticipated cash needs for the foreseeable future. If we did need to raise additional funds to expand our operations, invest in new products or for other corporate purposes, we may not be able to obtain additional debt or equity financing on favorable terms. If we raise additional equity financing, our stockholders may experience significant dilution of their ownership interests, and the market price of our common stock could decline. Furthermore, if we engage in debt financing, the holders of such debt would have priority over the holders of common stock, and we may be required to accept terms that restrict our ability to incur additional indebtedness or impose other restrictions on our business. We may also be required to take other actions that would otherwise be in the interests of the debt holders, including maintaining specified liquidity or other ratios, any of which could harm our business, financial condition, results of operations and prospects. If we need additional capital and cannot raise it on acceptable terms, we may not be able to, among other things, enhance our products and services, expand our sales and marketing and research and development organizations, acquire complementary technologies, products or businesses, and respond to competitive pressures or unanticipated working capital requirements.Our failure to do any of these things could seriously harm our business, financial condition, results of operations and prospects.
Risks Related to Customers and Sales
If we are unable to attract new large end customers or to sell additional products and services to our existing end customers, our revenue growth will be adversely affected and our revenue could decrease.
To increase our revenue, we must add new end customers and large end customers and sell additional products and services to existing end customers. For example, one of our sales strategies is to target specific projects at our current end customers because they are familiar with the operational and economic benefits of our solutions, thereby reducing the sales cycle into these customers. We also believe thisthe opportunity with current end customers to be significant given their existing infrastructure and expected future spend. Another one of our sales strategies is focused on increasing penetration in the enterprise and campus markets. EnterpriseHowever, sales strategies focused on expansion to adjacent markets can require more time and effort since enterprise and campus end customers typically start with small purchases, and there is often a long testing period. For this reason, in order to grow our revenue, it is important for us to attract new large end customers.Some factors that may limit our ability to attract new large end customers include, but are not limited to, saturation with certain of the large cloud networking customers, competition, decreased capital spending of such customers, a limited number of such customers, and a decline in growth of such customers. If we fail to attract new large end customers, including enterprise and campus end customers, or fail to reduce the sales cycle and sell additional products to our existing end customers, our business, financial condition, results of operations and prospects will be harmed.
We expect large purchases by a limited number of end customers to continue to represent a substantial portion of our revenue, and any loss, delay, decline or other change in expected purchases could result in material quarter-to-quarter fluctuations of our revenue or otherwise adversely affect our results of operations.
Historically, large purchases by a relatively limited number of end customers have accounted for a significant portion of our revenue, particularlyrevenue. We have experienced unpredictability in the cloud networking market. Manytiming 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 maketo evaluate, test, qualify and accept our products, and the overall complexity of these large purchases to complete or upgrade specific data center installationsorders. We expect continued variability in our customer concentration and are typically madetiming of sales on a purchase-order basis rather than pursuant to long-term contracts.quarterly and annual basis. For example, revenue from sales to our end customer Microsoft throughand Facebook in fiscal 2019 collectively represented 40% of our channel partner, World Wide Technology, Inc., accounted for 27%, 16% and 16%total revenue, whereas sales to our end customer Microsoft in fiscal 2020 amounted to 21.5% of our revenues, with our end customer Facebook representing less than 10% of our revenues in the period. These changes contributed to a year-over-year decline in our revenue for the years ended December 31, 2018, 2017 and 2016, respectively. Ourfiscal 2020 compared to fiscal 2019. However, this decline in revenue was offset in part by stronger sales to Microsoft as an end-userour 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 fiscal year ended December 31, 2018 benefited from certain factors that may not repeatperiod in fiscal 2019 or future years and the percentagewhich such sales occur.
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As a consequence of the concentrated nature of our customer base and their purchasing behavior, our quarterly revenue and results of operations may fluctuate from quarter to quarter and are difficult to estimate.Changes in the business requirements or focus, upgrade cycles, vendor selection, project prioritization, manner in which spending allocations are assigned among multiple vendors based upon specific network roles or projects, financial prospects, lack of growth of our customers, capital resources and expenditures or purchasing behavior and deceleration in spending of our key end customers could significantly decrease our sales to such end customers or could lead to delays, reductions or cancellations of planned purchases of our products or services. Moreover, because our sales will be based primarily on purchase orders, our customers may cancel, delay, reduce or otherwise modify their purchase commitments with little or no notice to us. This limited visibility regarding our end customers’ product needs, the timing and quantity of which could vary significantly, requires us to rely on estimated demand forecasts to determine how much material to purchase and product to manufacture. Our failure to accurately forecast demand can lead to product shortages which could lead to delays in fulfilling current and future purchase orders that can impede production by our customers and harm our customer relationships. And, in the event of a cancellation or reduction of an order, we may not have enough time to reduce operating expenses to mitigate the effect of the lost revenue on our business, which could materially affect our operating results.
We may be unable to sustain or increase our revenue from our large end customers, grow revenues with new or other existing end customers at the rate we anticipate or at all, or offset the discontinuation of concentrated purchases by our larger end customers with purchases by new or existing end customers. These customers can drive the growth in revenue for particular products and services based on factors such as: trends in the networking market, business mergers and acquisitions, trends in economic conditions and the overall fast growth of a customer's underlying business. These customers could choose to divert all or a portion of their business with us to one of our competitors, re-assign spending allocations, increase their adoption of "white box" solutions and open source network operating systems, demand pricing concessions for our services, or require us to provide enhanced services that increase our costs.costs, or reduce their spending levels. If these factors drove some of our large customers to cancel all or a portion of their business relationships with us, the growth in our business and the ability to meet our current and long-term financial forecasts may be materially impacted. We expect that such concentrated purchases will continue to contribute materially to our revenue for the foreseeable future and that our results of operations may fluctuate materially as a result of such larger end customers’ buying patterns. In addition, we may see consolidation of our customer base, such as among internetInternet companies and cloud service providers, which could result in loss of end customers. The loss of such end customers, or a significant delay or reduction in their purchases, including reductions or delays due to customer departures from recent buying patterns, or an unfavorable change in competitive conditions could materially harm our business, financial condition, results of operations and prospects.
If we are unable to increase market awareness of our company and our new products and services, our revenue may not continue to grow or may decline.
We have not yet established broad market awareness of our new products and services, including new products we introduced in the campus workspace and network security markets. Market awareness of our value proposition and products and services will be essential to our continued growth and our success, particularly for the service provider and broader enterprise markets. If our marketing efforts are unsuccessful in creating market awareness of our company and our products and services or in gaining access to new customer markets, then our business, financial condition, results of operations and prospects will be adversely affected, and we will not be able to achieve sustained growth.
Some of our large end customers require more favorable terms and conditions from their vendors and may request price concessions. As we seek to sell more products to these end customers, we may be required to agree to terms and conditions that may have an adverse effect on our business or ability to recognize revenue.
Our large end customers have significant purchasing power and, as a result, may receive more favorable terms and conditions than we typically provide to other end customers, including lower prices, bundled upgrades, extended warranties, acceptance terms, indemnification terms and extended return policies and other contractual rights. As we seek to sell more products to these large end customers, an increased mix of our shipments may be subject to such terms and conditions, which may reduce our margins or affect the timing of our revenue recognition and thus may have an adverse effect on our business, financial condition, results of operations and prospects.
Sales of our switches generate most of our product revenue, and if we are unable to continue to grow sales of these products, our business, financial condition, results of operations and prospects will suffer.
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Historically, we have derived substantially all of our product revenue from larger, well-established companies, and we may lack sufficient financial or other resources to maintain or improvesales of our competitive position.
The sales prices of our products and services may decrease, which may reduce our gross profits and adversely affect our results of operations.
The sales prices for our products and services may decline for a variety of reasons, including competitive pricing pressures, discounts, a change in our mix of products and services, the introduction of new products and services by us or by our competitors including the adoption of “white box” solutions, promotional programs, product and related warranty costs or broader macroeconomic factors. 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. Our gross margins may also fluctuate as a result of the timing of such sales to large end customers.
We have experienced declines in sales prices for our products.products and services. Competition continues to increase in the market segments in which we participate, and we expect competition to further increase in the future, thereby leading to increased pricing pressures. Larger competitors with more diverse product and service offerings may reduce the price of products and services that compete with ours or may bundle them with other products and services. Additionally, although we generally price our products and services worldwide in U.S. dollars, currency fluctuations in certain countries and regions may adversely affect actual prices that partners and end customers are willing to pay in those countries and regions. Furthermore, we anticipate that the sales prices and gross profits for our products willmay decrease over product life cycles. Decreased sales prices for any reason may reduce our gross profits and adversely affect our result of operations.
Our sales cycles can be long and unpredictable, and our sales efforts require considerable time and expense. As a result, our sales and revenue are difficult to predict and may vary substantially from period to period, which may cause our results of operations to fluctuate significantly.
The timing of our sales and revenue recognition is difficult to predict because of the length and unpredictability of our products’ sales cycles. A sales cycle is the period between initial contact with a prospective end customer and any sale of our products. End-customer orders often involve the purchase of multiple products. These orders are complex and difficult to complete because prospective end customers generally consider a number of factors over an extended period of time before committing to purchase the products and solutions we sell. End customers, especially our large end customers, often view the purchase of our products as a significant and strategic decision and require considerable time to evaluate, test and qualify our products prior to making a purchase decision and placing an order. The length of time that end customers devote to their evaluation, contract negotiation and budgeting processes varies significantly. In addition, customers may delay upgrades to their network infrastructure which extends the upgrade and sales cycle.Our products’ sales cycles can be lengthy in certain cases, especially with respect to our prospective large end customers. During the sales cycle, we expend significant time and money on sales and marketing activities and make investments in evaluation equipment, all of which lower our operating margins, particularly if no sale occurs. Even if an end customer decides to purchase our products, there are many factors affecting the timing of our recognition of revenue, which makes our revenue difficult to forecast. For example, there may be unexpected delays in an end customer’s internal procurement processes, particularly for some of our larger end customers for which our products represent a very small percentage of their total procurement activity. In addition, due to the COVID-19 pandemic, the sales cycle may be extended and there may be delays and reductions of expenditures and cancellations by end customers.There are many other factors specific to end customers that contribute to the timing of their purchases and the variability of our revenue recognition, including the strategic importance of a particular project to an end customer, budgetary constraints and changes in their personnel.
Even after an end customer makes a purchase, there may be circumstances or terms relating to the purchase that delay our ability to recognize revenue from that purchase. In addition, the significance and timing of our product
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enhancements, and the introduction of new products by our competitors, may also affect end customers’ purchases. For all of these reasons, it is difficult to predict whether a sale will be completed, the particular period in which a sale will be completed or the period in which revenue from a sale will be recognized. If our sales cycles lengthen, our revenue could be lower than expected, which would have an adverse effect on our business, financial condition, results of operations and prospects.
Our ability to sell our products is highly dependent on the quality of our support and services offerings, and our failure to offer high-quality support and services could have a material adverse effect on our business, financial condition, results of operations and prospects.
Once our products are deployed within our end customers’ networks, our end customers depend on our support organization and our channel partners to resolve any issues relating to our products. High-quality support is critical for the successful marketing and sale of our products. If we or our channel partners do not assist our end customers in deploying our products effectively, do not succeed in helping our end customers resolve post-deployment issues quickly or do not provide adequate ongoing support, or if we experience quality issues with these new products, it could adversely affect our ability to sell our products to existing end customers and could harm our reputation with potential end customers. In addition, as we expand our operations internationally, our support organization will face additional challenges, including those associated with delivering support, training and documentation in languages other than English. Our failure or the failure of our channel partners to maintain high-quality support and services could have a material adverse effect on our business, financial condition, results of operations and prospects.
Our business depends on end customers renewing their maintenance and support contracts. Any decline in maintenance renewals could harm our future business, financial condition, results of operations and prospects.
We typically sell our products with maintenance and support as part of the initial purchase, and a portion of our annual revenue comes from renewals of maintenance and support contracts. Our end customers have no obligation to renew their maintenance and support contracts after the expiration of the initial period, and they may elect not to renew their maintenance and support contracts, to renew their maintenance and support contracts at lower prices through alternative channel partners or to reduce the product quantity under their maintenance and support contracts, thereby reducing our future revenue from maintenance and support contracts. If our end customers, especially our large end customers, do not renew their maintenance and support contracts or if they renew them on terms that are less favorable to us, our revenue may decline and our business, financial condition, results of operations and prospects will suffer.
Under the indemnification provisions of our standard sales contracts, we agree to defend our end customers and we will not be ablechannel partners against third-party claims asserting infringement of certain intellectual property rights, which may include patents, copyrights, trademarks or trade secrets, and to achieve sustained growth.
Our exposure under these indemnification provisions is frequently limited to legally work in the United States and other countries. The United States has recently increasedtotal amount paid by our end customer under the level of scrutiny in granting H-1(B), L-1 and other business visas, and the current administration has indicatedagreement. However, certain agreements include indemnification provisions that immigration reform is a priority. Our compliance with United States immigration and labor laws could requirepotentially expose us to incur additional unexpected labor costs and expenses orlosses in excess of the amount received under the agreement. Any of these events, including claims for indemnification, could restrain our ability to retain skilled professionals.
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Our future success is highly dependent upon maintaining our relationships with distributors, systems integrators and value-added resellers and establishing additional sales channel relationships. We anticipate that sales of our products to our existing end customers, and our business will be adversely affected.
Where we rely on the channel partners for sales of our products, we may have little or no contact with the ultimate users of our products that purchase through such channel partners, thereby making it more difficult for us to establish brand awareness, ensure proper delivery and installation of our products, service ongoing end-customer requirements, estimate end-customer demand and respond to evolving end-customer needs. In addition, our channel partner sales structure could subject us to lawsuits, potential liability and reputational harm if, wefor example, any of our channel partners misrepresent the functionality of our products or our intermediariesservices to end customers, fail to comply with the requirements of the FCPAtheir contractual obligations or similar legislation, governmental authorities in the U.S. and elsewhere could seekviolate laws or our corporate policies. If we fail to impose civil and/or criminal fines and penalties which could have a material adverse effect on our business, results of operations and financial conditions. Failure to comply with anti-corruption and anti-bribery laws, such as the FCPA and the United Kingdom Bribery Act of 2010, or the U.K. Bribery Act, and similar laws associated with our activities outside the U.S., could subject us to penalties and other adverse consequences. We intend to increase our international sales and business and, as such, the risk of violating laws such as the FCPA and U.K. Bribery Act increases.
We anticipate increasing our sales efforts to U.S. and foreign, federal, state and local governmental end customers in the procurement, budgetingfuture. Sales to government entities are subject to a number of risks. Selling to government entities can be highly competitive, expensive and deployment cycles of manytime consuming, often requiring significant upfront time and expense without any assurance that these efforts will generate a sale. The substantial majority of our end customers. Our rapid historical growthsales to date to government entities have been made indirectly through our channel partners. Government certification requirements for products like ours may change and, in doing so, restrict our ability to sell into the government sector until we have attained revised certifications. Government demand and payment for our products and services may be affected by public sector budgetary cycles and funding authorizations, with funding reductions or delays adversely affecting public sector demand for our products and services. Government entities may have reduced thestatutory, contractual or other legal rights to terminate contracts with our distributors and resellers for convenience or due to a default, and any such termination may adversely impact of seasonal or cyclical factors that might have influenced our business to date. As our increasing size causes our growth rate to slow, seasonal or cyclical variations in our operations may become more pronounced over time and may materially affect ourfuture business, financial condition, results of operations and prospects.
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purchases contain a certain threshold of “domestic origin” components in order to meet “Buy America” requirements.
We are exposed to the credit risk of our channel partners and some of our end customers, which could result in material losses.
Most of our sales are on an open credit basis, with standard payment terms of 30 days in the United States and, because of local customs or conditions, longer in some markets outside the U.S. We monitor individual end-customer payment capability in granting such open credit arrangements, seek to limit such open credit to amounts we believe the end customers can pay and maintain reserves we believe are adequate to cover exposure for doubtful accounts. We are unable to recognize revenue from shipments until the collection of those amounts becomes reasonably assured. Any significant delay or default in the collection of significant accounts receivable could result in an increased need for us to obtain working capital from other sources, possibly on worse terms than we could have negotiated if we had established such working capital resources prior to such delays or defaults. Any significant default could adversely affect our results of operations and delay our ability to recognize revenue.
A material portion of our sales is derived through our distributors, systems integrators and value-added resellers. Some of our distributors, systems integrators and value-added resellers may experience financial difficulties, which could adversely affect our collection of accounts receivable. Distributors tend to have more limited financial resources than other systems integrators, value-added resellers and end customers. Distributors represent potential sources of increased credit risk because they may be less likely to have the reserve resources required to meet payment obligations. Our exposure to credit risks of our channel partners may increase if our channel partners and their end customers are adversely affected by global or regional economic conditions. One or more of these channel partners could delay payments or default on credit extended to them, either of which could materially adversely affect our business, financial condition, results of operations and prospects.
Risks Related to Products and Services
Product quality problems, defects, errors or vulnerabilities in our products or services could harm our reputation and adversely affect our business, financial condition, results of operations and prospects.
We produce highly complex products that incorporate advanced technologies, including both hardware and software technologies. Despite testing prior to their release, our products may contain undetected defects or errors, especially when first introduced or when new versions are released. Product defects or errors could affect the performance of our products, could result in a failure of appropriate updates to be distributed or installed, could delay the development or release of new products or new versions of products, and could result in warranty claims and product liability claims from customers. Any actual or perceived defect, error, or vulnerability in our products or services, or other allegations of unsatisfactory performance could cause us to lose revenue or market share, increase our service costs, cause us to incur substantial costs in analyzing, correcting or redesigning the products or otherwise addressing defects, errors or vulnerabilities, cause us to lose significant end customers, harm our reputation and market positions, subject us to liability for damages, subject us to litigation, regulatory inquiries or investigations, and divert our resources from other tasks, any one of which could materially adversely affect our business, financial condition, results of operations and prospects.
From time to time, we have had to replace certain components of products that we had shipped and provide remediation in response to the discovery of defects or bugs, including failures in software protocols or defective component batches resulting in reliability issues, in such products, and we may be required to do so in the future. We may also be required to provide full replacements or refunds for such defective products. We cannot assure you that such remediation or any of the other circumstances described above, including claims, litigation, or regulatory investigations, would not have a material effect on our business, financial condition, results of operations and prospects.
If we do not successfully anticipate technological shifts and develop products and product enhancements that meet those technological shifts, if those products are not made available in a timely manner or do not gain market acceptance, or if we do not successfully manage product introductions, we may not be able to compete effectively, and our ability to generate revenue will suffer.
We must continue to enhance our existing products and develop new technologies and products that address emerging technological trends, evolving industry standards and changing end-customer needs. The process
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of enhancing our existing products and developing new technology is complex and uncertain, and new offerings requires significant upfront investment that may not result in material design improvements to existing products or result in marketable new products or costs savings or revenue for an extended period of time, if at all.
In addition, new technologies could render our existing products obsolete or less attractive to end customers, and our business, financial condition, results of operations and prospects could be materially adversely affected if such technologies are widely adopted. For example, end customers may prefer to address their network switch requirements by licensing software operating systems separately and placing them on “white box” hardware rather than purchasing integrated hardware products as has occurred in the server industry. Additionally, end customers may require product upgrades including higher Ethernet speeds and additional functionality to address the increasing demands of the cloud computing environments.
In the past several years, we have announced a number of new products and enhancements to our products and services, including new products in the campus workspace and network security markets. The success of our new products depends on several factors including, but not limited to, appropriate new product definition, the development of product features that sufficiently meet end-user requirements, our ability to manage the risks associated with new product production ramp-up issues, component costs, availability of components, timely completion and introduction of these products, prompt solution of any defects or bugs in these products, our ability to support these products, differentiation of new products from those of our competitors and market acceptance of these products. For example, our new product releases will require strong execution from our third-party merchant silicon chip suppliers to develop and release new merchant silicon chips that satisfy end-customer requirements, to meet expected release schedules and to provide sufficient quantities of these components. If we are unable to successfully manage our product introductions or transitions, or if we fail to penetrate new markets, as a result of any of these or other factors, our business, financial condition, results of operations and prospects could be adversely affected.
Our product releases introduced new software products that include the capability for disaggregation of our software operating systems from our hardware. The success of our strategy to expand our software business is subject to a number of risks and uncertainties including the additional development efforts and costs to create these new products or make them compatible with other technologies, the potential for our strategy to negatively impact revenues and gross margins and additional costs associated with regulatory compliance.
We may not be able to successfully anticipate or adapt to changing technology or end-customer requirements on a timely basis, or at all. If we fail to keep up with technology changes or to convince our end customers and potential end customers of the value of our solutions even in light of new technologies, we may lose customers, decrease or delay market acceptance and sales of our present and future products and services and materially and adversely affect our business, financial condition, results of operations and prospects.
Our products must interoperate with operating systems, software applications and hardware that is developed by others, and if we are unable to devote the necessary resources to ensure that our products interoperate with such software and hardware, we may lose or fail to increase market share and experience a weakening demand for our products.
Generally, our products comprise only a part of the network infrastructure and must interoperate with our end customers’ existing infrastructure, specifically their networks, servers, software and operating systems, which may be manufactured by a wide variety of vendors and original equipment manufacturers, or OEMs. Our products must comply with established industry standards in order to interoperate with the servers, storage, software and other networking equipment in the network infrastructure such that all systems function efficiently together. We depend on the vendors of servers and systems in a data center to support prevailing industry standards. Often, these vendors are significantly larger and more information regardinginfluential in driving industry standards than we are. Also, some industry standards may not be widely adopted or implemented uniformly and competing standards may emerge that may be preferred by our end customers.
In addition, when new or updated versions of these software operating systems or applications are introduced, we must sometimes develop updated versions of our software so that our products will interoperate properly. We may not accomplish these development efforts quickly, cost-effectively or at all. These development efforts require capital investment and the devotion of engineering resources. If we fail to maintain compatibility with these systems and applications, our end customers may not be able to adequately utilize our products, and we may
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lose or fail to increase market share and experience a weakening in demand for our products, among other consequences, which would adversely affect our business, financial condition, results of operations and prospects.
Risks Related to Supply Chain and Manufacturing
Managing the supply of our products and product components is complex. Insufficient component supply and inventory may result in lost sales opportunities or delayed revenue, while excess inventory may harm our gross margins.
Managing our extended supply chain is complex, and our inventory management systems and related supply-chain visibility tools may not enable us to forecast accurately and effectively manage the supply of our products and product components. Our ability to manage our supply chain may also be adversely affected by other factors including shortages of components used to manufacture our products, a reduction or interruption of supply, prioritization of component shipments to other vendors, cessation of manufacturing of such components by our suppliers and geopolitical conditions such as the U.S. trade war with China and the impact of public health epidemics like the COVID-19 pandemic. Insufficient component supply, or any increases in the time required to manufacture our products, may lead to inventory shortages that could result in increased customer lead times for our products, delayed revenue or loss of sales opportunities altogether as potential end customers turn to competitors’ products that are readily available. In addition, the COVID-19 pandemic has created manufacturing and supply chain disruptions, including temporary closures of certain of our contract manufacturer facilities and shortages of certain components and, as a result, has extended lead times for our products.
In order to reduce manufacturing lead times and plan for adequate component supply, from time to time we may issue purchase orders for components and products that are non-cancelable and non-returnable. In addition, we may purchase components and products that have extended lead teams to ensure adequate supply to support long-term customer demand and mitigate the impact of COVID-19 related supply disruptions. We establish a liability for non-cancelable, non-returnable purchase commitments with our component inventory suppliers for quantities in excess of our demand forecasts, or for products that are considered obsolete. In addition, we establish a liability and reimburse our contract manufacturer for component inventory purchased on our behalf that has been rendered excess or obsolete due to manufacturing and engineering change orders, or in cases where inventory levels greatly exceed our demand forecasts. If we ultimately determine that we have excess inventory or obsolete inventory, we may have to reduce our prices and write down inventory to its estimated realizable value, which in turn could result in lower gross margins. If we are unable to effectively manage our supply and inventory, our business, financial condition, results of operations and prospects could be adversely affected.
Because some of the key components in our products come from sole or limited sources of supply, we are susceptible to supply shortages or supply changes, which could disrupt or delay our scheduled product deliveries to our end customers and may result in the loss of sales and end customers.
Our products rely on key components, including merchant silicon chips, integrated circuit components, printed circuit boards, connectors, custom-tooled sheet metal and power supplies that we purchase or our contract manufacturers purchase on our behalf from a limited number of suppliers, including certain sole source providers. Generally, we do not have guaranteed supply contracts with our component suppliers, and our suppliers could suffer shortages, delay shipments, prioritize shipments to other vendors, increase prices or cease manufacturing such products or selling them to us at any time. Supply of these components may also be adversely affected by industry consolidation which could result in increased component prices or fewer sourcing options as well as geopolitical conditions such as international trade wars like the U.S. trade war with China and the impact of public health epidemics like the COVID-19 pandemic. For example, in the past, we have experienced shortages in inventory for dynamic random access memory integrated circuits and delayed releases of the next generation of chipset, which delayed our production and/or the release of our new products. We have also recently experienced shortages and delays relating to certain components as a result of manufacturing and supply disruptions due to the COVID-19 pandemic.
If we are unable to obtain sufficient quantities of these components on commercially reasonable terms or in a timely manner, or if we are unable to obtain alternative sources for these components, sales of our products could be delayed or halted entirely or we may be required to redesign our products. Any of these events could result in lost sales, reduced gross margins or damage to our end customer relationships, which would adversely impact our business, financial condition, results of operations and prospects.
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Our reliance on component suppliers also yields the potential for the infringement or misappropriation of third-party intellectual property rights due to the incorporation of such components into our products. We may not be indemnified by such component suppliers for such infringement or misappropriation claims. Any litigation infor which we do not receive indemnification could require us to incur significant legal expenses in defending against such claims or require us to pay substantial royalty payments or settlement amounts that would not be reimbursed by our component suppliers.
Our product development efforts are also dependent upon the success of our continued collaboration with our key merchant silicon vendors such as Broadcom and Intel. As we develop our product roadmap, we select specific merchant silicon from these vendors for each new product. It is critical that we work in tandem with these vendors to ensure that their silicon includes improved features, that our products take advantage of such improved features, and that such vendors are able to supply us with sufficient quantities on commercially reasonable term to meet customer demand. Reliance on these relationships allows us to focus our research and development resources on our software core competencies while leveraging their investments and expertise. The merchant silicon vendors may not be successful in continuing to innovate, meet deadlines for the release of their products or produce a sufficient supply of their products. Moreover, these vendors may not collaborate with us or may become competitive with us by selling merchant silicon for “white boxes” or other products to our customers.
If our key merchant silicon vendors do not continue to innovate, if there are delays in the release of their products or supply shortages, if they no longer collaborate in such fashion or if such merchant silicon is not offered to us on commercially reasonable terms, our products may become less competitive, our own product launches could be delayed or we may be required to redesign our products to incorporate alternative merchant silicon, which could result in lost sales, reduce gross margins, damage to our customer relationships or otherwise have a material effect on revenue and business, financial condition, results of operations and prospects.
In the event of a shortage or supply interruption from our component suppliers, we may not be able to develop alternate or second sources in a timely manner. Further, long-term supply and maintenance obligations to end customers increase the duration for which specific components are required, which may increase the risk of component shortages or the cost of carrying inventory. In addition, our component suppliers change their selling prices frequently in response to market trends, including industry-wide increases in demand, and because we do not have contracts with these suppliers or guaranteed pricing, we are susceptible to availability or price fluctuations related to raw materials and components. If we are unable to pass component price increases along to our end customers or maintain stable pricing, our gross margins could be adversely affected and our business, financial condition, results of operations and prospects could suffer.
Because we depend on third-party manufacturers to build our products, we are susceptible to manufacturing delays and pricing fluctuations that could prevent us from shipping end-customer orders on time, if at all, or on a cost-effective basis, which may result in the loss of sales and end customers.
We depend on third-party contract manufacturers to manufacture our product lines. A significant portion of our cost of revenue consists of payments to these third-party contract manufacturers. Our reliance on these third-party contract manufacturers reduces our control over the manufacturing process, quality assurance, product costs and product supply and timing, which exposes us to risk. Our reliance on contract manufacturers also yields the potential for their infringement of third party intellectual property rights in the manufacturing of our products or their misappropriation of our intellectual property rights in the manufacturing of other customers’ products. If we are unable to manage our relationships with our third-party contract manufacturers effectively, or if these third-party manufacturers suffer delays or disruptions or quality control problems in their operations, experience increased manufacturing lead times, capacity constraints or fail to meet our future requirements for timely delivery, our ability to ship products to our end customers would be severely impaired, and our business, financial condition, results of operations and prospects would be seriously harmed.
To the extent that our products are manufactured at facilities in foreign countries, we may be subject to additional risks associated with complying with local rules and regulations in those jurisdictions, including shelter in place orders issued in connection with the COVID-19 pandemic. For example, due to the COVID-19 pandemic, some of our contract manufacturers experienced temporary closures and labor shortages as a result of shelter in place orders similar to the orders currently issued in their local jurisdictions. While our manufacturing sites are currently involved, seeoperational, further shelter in place orders or factory closures in these or other manufacturing sites would result in material disruptions, increased lead times and supply shortages of our products.
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Our contract manufacturers typically fulfill our supply requirements on the “Legal Proceedings” subheadingbasis of individual orders. We do not have long-term contracts with our third-party manufacturers that guarantee capacity, the continuation of particular pricing terms or the extension of credit limits. Accordingly, they are not obligated to continue to fulfill our supply requirements, which could result in supply shortages, and the prices we are charged for manufacturing services could be increased on short notice. For example, a competitor could place large orders with the third-party manufacturer, thereby utilizing all or substantially all of such third-party manufacturer’s capacity and leaving the manufacturer little or no capacity to fulfill our individual orders without price increases or delays, or at all. Our contract with one of our contract manufacturers permits it to terminate the agreement for convenience, subject to prior notice requirements. We may not be able to develop alternate or second contract manufacturers in Note 7. Commitmentsa timely manner.
If we add or change contract manufacturers or change any manufacturing plant locations within a contract manufacturer network, we would add additional complexity and Contingenciesrisk to our supply chain management and may increase our working capital requirements. Ensuring a new contract manufacturer or new plant location is qualified to manufacture our products to our standards and industry requirements could take significant effort and be time consuming and expensive. Any addition or change in manufacturers may be extremely costly, time consuming and we may not be able to do so successfully.
In addition, we may be subject to additional significant challenges to ensure that quality, processes and costs, among other issues, are consistent with our expectations and those of our customers. A new contract manufacturer or manufacturing location may not be able to scale its production of our products at the Notesvolumes or quality we require. This could also adversely affect our ability to Consolidated Financial Statements includedmeet our scheduled product deliveries to our end customers, which could damage our customer relationships and cause the loss of sales to existing or potential end customers, late delivery penalties, delayed revenue or an increase in Part II, Item 8,our costs which could adversely affect our gross margins. This could also result in increased levels of this Annual Reportinventory subjecting us to increased excess and obsolete charges that could have a negative impact on Form 10-K incorporated hereinour operating results.
Any production interruptions, labor shortages or disruptions for any reason, including those noted above, as well as a natural disaster, epidemic (such as the COVID-19 pandemic), capacity shortages, adverse results from intellectual property litigation or quality problems, at one of our manufacturing partners would adversely affect sales of our product lines manufactured by reference.that manufacturing partner and adversely affect our business, financial condition, results of operations and prospects.
We base our inventory requirements on our forecasts of future sales. If these forecasts are materially inaccurate, we may procure inventory that we may be unable to use in a timely manner or at all.
We and our contract manufacturers procure components and build our products based on our forecasts. These forecasts are based on estimates of future demand for our products, which are in turn based on historical trends and analysis from our sales and marketing organizations, adjusted for overall market conditions and other factors. To the extent our forecasts are materially inaccurate or if we otherwise do not need such inventory, we may under- or over-procure inventory, and such inaccuracies in our forecasts could materially adversely affect our business, financial condition and results of operations.
Risks Related to Intellectual Property and Other Proprietary Rights
Assertions by third parties of infringement or other violations by us of their intellectual property rights, or other lawsuits asserted against us, could result in significant costs and substantially harm our business, financial condition, results of operations and prospects.
Patent and other intellectual property disputes are common in the network infrastructure, industrynetwork security and Wi-Fi industries and have resulted in protracted and expensive litigation for many companies. Many companies in the network infrastructure, industry,network security and Wi-Fi industries, including our competitors and other third parties, as well as non-practicing entities, own large numbers of patents, copyrights, trademarks and trade secrets, which they may use to assert claims of patent infringement, misappropriation, or other violations of intellectual property rights against us. From time to time, they have or may in the future also assert such claims against us, our end customers or channel partners whom we typically indemnify against claims that our products infringe, misappropriate or otherwise violate the intellectual property rights of third parties. For example, we are currently a party to litigation involving OptumSoft described elsewhere in these risk factors and we have previously been involved in litigation with Cisco.Cisco and OptumSoft.
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As the number of products and competitors in our market increases and overlaps occur or if we enter into new markets, claims of infringement, misappropriation and other violations of intellectual property rights may increase. Any claim of infringement, misappropriation or other violations of intellectual property rights by a third party, even those without merit, could cause us to incur substantial costs defending against the claim, distract our management from our business and require us to cease use of such intellectual property. In addition, some claims for patent infringement may relate to subcomponents that we purchase from third parties. If these third parties are unable or unwilling to indemnify us for these claims, we could be substantially harmed.
The patent portfolios of most of our competitors are larger than ours. This disparity may increase the risk that our competitors may sue us for patent infringement and may limit our ability to counterclaim for patent infringement or settle through patent cross-licenses. In addition, future assertions of patent rights by third parties, and any resulting litigation, may involve patent holding companies or other adverse patent owners who have no relevant product revenue and against whom our own patents may therefore provide little or no deterrence or protection. We cannot assure you that we are not infringing or otherwise violating any third-party intellectual property rights.
The third-party asserters of intellectual property claims may be unreasonable in their demands, or may simply refuse to settle, which could lead to expensive settlement payments, prolongedlonger periods of litigation and related expenses, additional burdens on employees or other resources, distraction from our business, supply stoppages and lost sales.
An adverse outcome of a dispute (including those lawsuits described under the “Legal Proceedings” subheading in Note 7. Commitments and Contingencies and the settlement with Cisco described in Note 14. Legal Settlement of Notes to Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K) may require us to pay substantial damages or penalties including treble damages if we are found to have willfully infringed a third party’s patents; cease making, licensing, using or importing into the U.S. products or services that are alleged to infringe or misappropriate the intellectual property of others; expend additional development resources to attempt to redesign our products or services or otherwise to develop non-infringing technology, which may not be successful; enter into potentially unfavorable royalty or license agreements in order to obtain the right to use necessary technologies or intellectual property rights; and indemnify our partners and other third parties. Any damages, penalties or royalty obligations we may become subject to as a result of an adverse outcome, and any third-party indemnity we may need to provide, could harm our business, financial condition, results of operations and prospects. Royalty or licensing agreements, if required or desirable, may be unavailable on terms acceptable to us, or at all, and may require significant royalty payments and other expenditures. Further, there is little or no information publicly available concerning market or fair values for license fees, which can lead to overpayment of license or settlement fees. In addition, some licenses may be non-exclusive, and therefore our competitors may have access to the same technology licensed to us. Suppliers subject to third-party intellectual property claims also may choose or be forced to discontinue or alter their arrangements with us, with little or no advance notice to us. Any of these events could seriously harm our business, financial condition, results of operations and prospects.
In the event that we are found to infringe any third party intellectual property, we could be enjoined, or subject to other remedial orders that would prohibit us, from making, licensing, using or importing into the U.S. such products or services. In order to resume such activities with respect to any affected products or services, we (or our component suppliers) would be required to develop technical redesigns to this third party intellectual property that no longer infringe the third party intellectual property. In any efforts to develop technical redesigns for these products or services, we (or our component suppliers) may be unable to do so in a manner that does not continue to infringe the third party intellectual property or that is acceptable to our customers. These redesign efforts could be extremely costly and time consuming as well as disruptive to our other development activities and distracting to management. Moreover, such redesigns could require us to obtain approvals from the court or administrative body to resume the activities with respect to these affected solutions. We may not be successful in our efforts to obtain such approvals in a timely manner, or at all. Any failure to effectively redesign our solutions or to obtain timely approval of those redesigns by a court or administrative body may cause a disruption to our product shipments and materially and adversely affect our business, prospects, reputation, results of operations, and financial condition. For example, in two prior investigations brought by Cisco in the International Trade
Commission (“ITC”), we were subjected to remedial orders that prohibited us from importing and selling after importation any products the ITC found to infringe Cisco’s patents. As a result, we were required to redesign certain aspects of our products and obtain U.S. Customs and Border Protection’s approval of those redesigns before we could continue to import those products into the United States.
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If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights.
We depend on our ability to protect our proprietary technology. We rely on trade secret, patent, copyright and trademark laws and confidentiality agreements with employees and third parties, all of which offer only limited protection.
The process of obtaining patent protection is expensive and time-consuming, and we may not be able to prosecute all necessary or desirable patent applications at a reasonable cost or in a timely manner. We may choose not to seek patent protection for certain innovations and may choose not to pursue patent protection in certain jurisdictions. Further, we do not know whether any of our pending patent applications will result in the issuance of patents or whether the examination process will require us to narrow our claims. To the extent that additional patents are issued from our patent applications, which is not certain, they may be contested, circumvented or invalidated in the future. Moreover, the rights granted under any issued patents may not provide us with proprietary protection or competitive advantages, and, as with any technology, competitors may be able to develop similar or superior technologies to our own now or in the future. In addition, we rely on confidentiality or license agreements with third parties in connection with their use of our products and technology. There is no guarantee that such parties will abide by the terms of such agreements or that we will be able to adequately enforce our rights, in part because we rely on “shrink-wrap” licenses in some instances.
We have not registered our trademarks in all geographic markets. Failure to secure those registrations could adversely affect our ability to enforce and defend our trademark rights and result in indemnification claims. Further, any claim of infringement by a third party, even those claims without merit, could cause us to incur substantial costs defending against such claim, could divert management attention from our business and could require us to cease use of such intellectual property in certain geographic markets.
Despite our efforts, the steps we have taken to protect our proprietary rights may not be adequate to preclude misappropriation of our proprietary information or infringement of our intellectual property rights, and our ability to police such misappropriation or infringement is uncertain, particularly in countries outside of the United States.
Detecting and protecting against the unauthorized use of our products, technology and proprietary rights is expensive, difficult and, in some cases, impossible. Litigation may be necessary in the future to enforce or defend our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Such litigation could result in substantial costs and diversion of management resources, either of which could harm our business, financial condition, results of operations and prospects, and there is no guarantee
that we would be successful. Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to protecting their technology or intellectual property rights than we do. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property, which could result in a substantial loss of our market share.
We rely on the availability of licenses to third-party software and other intellectual property.
Many of our products and services include software or other intellectual property licensed from third parties, and we otherwise use software and other intellectual property licensed from third parties in our business. This exposes us to risks over which we may have little or no control. For example, a licensor may have difficulties keeping up with technological changes or may stop supporting the software or other intellectual property that it licenses to us. Also, it will be necessary in the future to renew licenses, expand the scope of existing licenses or seek new licenses, relating to various aspects of these products and services or otherwise relating to our business, which may result in increased license fees. These licenses may not be available on acceptable terms, if at all. In addition, a third party may assert that we or our end customers are in breach of the terms of a license, which could, among other things, give such third party the right to terminate a license or seek damages from us, or both. The inability to obtain or maintain certain licenses or other rights or to obtain or maintain such licenses or rights on favorable terms, or the need to engage in litigation regarding these matters, could result in delays in releases of products and services and could otherwise disrupt our business, until equivalent technology can be identified, licensed or developed, if at all, and integrated into our products and services or otherwise in the conduct of our business. Moreover, the inclusion in our products and services of software or other intellectual property licensed from third parties on a nonexclusive
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basis may limit our ability to differentiate our products from those of our competitors. Any of these events could have a material adverse effect on our business, financial condition, results of operations and prospects.
Our products contain third-party open source software components, and failure to comply with the terms of the underlying open source software licenses could restrict our ability to sell our products.
Our products contain software modules licensed to us by third-party authors under “open source” licenses. Use and distribution of open source software may entail greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or other contractual protections regarding infringement claims or the quality of the code. Some open source licenses contain requirements that we make available source code for modifications or derivative works we create based upon the type of open source software that we use. If we combine our software with open source software in a certain manner, we could, under certain open source licenses, be required to release portions of the source code of our software to the public. This would allow our competitors to create similar products with lower development effort and time and ultimately could result in a loss of product sales for us.
Although we monitor our use of open source software to avoid subjecting our products to conditions we do not intend, the terms of many open source licenses have not been interpreted by U.S. courts, and these licenses could be construed in a way that could impose unanticipated conditions or restrictions on our ability to commercialize our products. Moreover, we cannot assure you that our processes for controlling our use of open source software in our products will be effective. If we are held to have breached the terms of an open source software license, we could be required to seek licenses from third parties to continue offering our products on terms that are not economically feasible, to re-engineer our products, to discontinue the sale of our products if re-engineering could not be accomplished on a timely basis or to make generally available, in source code form, our proprietary code, any of which could adversely affect our business, financial condition, results of operations and prospects.
We provide access to our software and other selected source code to certain partners, which creates additional risk that our competitors could develop products that are similar to or better than ours.
Our success and ability to compete depend substantially upon our internally developed technology, which is incorporated in the source code for our products. We seek to protect the source code, design code, documentation and other information relating to our software, under trade secret, patent and copyright laws. However, we have chosen to provide access to selected source code of our software to several of our partners for co-development, as well as for open application programming interfaces or APIs,("APIs"), formats and protocols. Though we generally control access to our source code and other intellectual property and enter into confidentiality or license agreements with such partners as well as with our employees and consultants, this combination of procedural and contractual safeguards may be insufficient to protect our trade secrets and other rights to our technology. Our protective measures may be inadequate, especially because we may not be able to prevent our partners, employees or consultants from violating any agreements or licenses we may have in place or abusing their access granted to our source code. Improper disclosure or use of our source code could help competitors develop products similar to or better than ours.
Risks Related to Litigation
We expect our gross marginsmay become involved in litigation that may materially adversely affect us.
From time to vary over time, andwe may become involved in legal proceedings relating to be adversely affected by numerous factors.
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For more information regarding the litigation in which we have been involved, see the “Legal Proceedings” subheading in Note 7. Commitments and Contingencies of the Notes to Condensed Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K incorporated herein by reference.
Risks Related to Cybersecurity and Data Privacy
Defects, errors or acquire other businesses whichvulnerabilities in our products, the failure of our products to detect security breaches, the misuse of our products or the risks of product liability could require significant management attention,harm our reputation and adversely impact our operating results.
Our products, services and internal network systems could become a target for security attacks, including attacks specifically designed to disrupt our business dilute stockholder value and adversely affect our business,customers and introduce malicious software and attacks by state sponsors. If our products, services or internal networks, system or data are or are perceived to have been compromised, our reputation may be damaged and our financial condition, results may be negatively affected.
Organizations are increasingly subject to a wide variety of operationsattacks on their networks, systems, endpoints, products and prospects.
The classifications of application type, virus, spyware, vulnerability exploits, data, or URL categories by our security platform may also falsely detect, report and act on applications, content, or threats that do not actually exist. These false positives may impair the perceived reliability of our security platform and may therefore adversely impact market acceptance of our security platform. Any such false identification of important files or applications could result in damage to our reputation, negative publicity, loss of channel partners, end-customers and sales, increased costs to remedy any problem, and costly litigation.
Breaches of our cybersecurity systems, or other security breaches or incidents with respect to our products, services, networks, systems, or data, could degrade our ability to conduct our business operations and deliver products and services to our customers, delay our ability to recognize revenue, compromise the integrity of our software products and our networks, systems, and data, result in significant data losses and the theft of our intellectual property, damage our reputation, expose us to liability to third parties and require us to incur significant additional costs to maintain the security of our networks and data.
We increasingly depend upon our IT systems to conduct virtually all of our business operations, ranging from our internal operations and product development activities to our marketing and sales efforts and communications with our customers and business partners. Computer programmers or other persons or organizations may attempt to penetrate our network security, or that of our website or systems, and access or obtain confidential, personal, or otherwise sensitive or proprietary information about us or our customers or cause interruptions of our service. These risks may increase due to the current COVID-19 pandemic. Because the techniques used to access or sabotage networks and systems change frequently and may not be recognized until launched against a target, we may be unable to anticipate these techniques. In addition, our software and sophisticated hardware and operating system software and applications that we produce or procure from third parties may contain defects in design or manufacture, including “bugs” and other problems that could cause the software or applications to fail or otherwise to unexpectedly interfere with the operation of the system. We face risks of others gaining unauthorized access to our products and services and introducing malicious software. We have also outsourced a number of our business functions to third-parties, including our manufacturers, logistics providers, and cloud service providers, and our business operations also depend, in part, on the success of these third parties’ own cybersecurity measures. Similarly, we rely upon distributors, resellers and system integrators to sell our products and our sales operations depend, in part, on the reliability of their cybersecurity measures. Additionally, we depend upon our employees to appropriately handle confidential data and deploy our IT resources with the use of security measures designed to prevent exposure of our network systems to security breaches and the loss of data. We and all of the aforementioned
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third parties also face the risk of malicious software, phishing schemes and other social engineering methods, fraud and other malfeasance, cybersecurity threats from state sponsors, and intentional or negligent acts or omissions of employees and contractors. Furthermore, our acquisition of Awake Security and our provision of its NDR platform may result in us being a more attractive target for such attacks. Accordingly, if our cybersecurity systems and measures or those of any of the aforementioned third parties fail to protect against sophisticated cyber-attacks, the mishandling of data by employees and contractors, or any other means of unauthorized access to, or use of, our manufacturing process, products, services, networks, systems, or data that we or such third parties maintain, operate, or process, our ability to conduct our business effectively could be damaged in a number of ways, including:
•sensitive data regarding our business or our customers, including intellectual property and other proprietary data, could be stolen;
•our electronic communications systems, including email and other methods, or other systems, could be disrupted, and our ability to conduct our business operations could be seriously damaged until such systems can be restored, which we may be unable to achieve in a prompt manner or at all;
•our ability to process customer orders and electronically deliver products and services could be degraded, and our distribution channels could be disrupted, resulting in delays in revenue recognition;
•defects and security vulnerabilities could be introduced into our software, thereby damaging the reputation and perceived reliability and security of our products and potentially making the data systems of our customers vulnerable to further data loss and cyber incidents;
•our manufacturing process, products, services, supply chain, network systems and data could be corrupted; and
•personal data of our customers, employees, contractors, and business partners could be accessed, obtained, or used without authorization, or otherwise compromised.
Should any of the above events occur, or be perceived to occur, we could be subject to significant claims for liability from our customers and others and regulatory investigations and actions from governmental agencies, and we could be required to expend significant capital and other resources to remediate and otherwise address any data security incident or breach, including to notify individuals, entities, or regulatory bodies and to implement measures in an effort to prevent further breaches or incidents. In addition, our ability to protect our intellectual property rights could be compromised and our reputation and competitive position could be significantly harmed. Also, the regulatory and contractual actions, litigation, investigations, fines, penalties and liabilities relating to data breaches that result in losses of, damage or destruction of, or unauthorized access to or acquisition of, credit card information or other personal or sensitive data of users of our services can be significant in terms of fines and reputational impact and necessitate changes to our business operations that may be disruptive to us. Additionally, we could incur significant costs in order to upgrade our cybersecurity systems and other measures in an effort to prevent security breaches and other incidents. Even the perception of inadequate security may damage our reputation and negatively impact our ability to win new customers and retain existing customers. Consequently, our financial condition,performance and results of operations could be adversely affected by any of the foregoing types of security breaches, incidents, vulnerabilities, or other matters, or the perception that any of them have occurred.
In addition, we cannot assure that any limitation of liability provisions in our customer agreements, contracts with third-party vendors and prospects. service providers or other contracts would be enforceable or adequate or would otherwise protect us from any liabilities or damages with respect to any particular claim relating to a security breach or other security-related matter. We also cannot be certain that our insurance coverage will be adequate for data handling or data security liabilities actually incurred, that insurance will continue to be available to us on economically reasonable terms, or at all, or that any future claim will not be excluded or otherwise be denied coverage by any insurer. The successful assertion of one or more large claims against us that exceed available insurance coverage, or the occurrence of changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could have a material adverse effect on our business, including our reputation, financial condition and operating results.
Risks Related to Accounting, Compliance. Regulation and Tax
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If we need additional capitalfail to maintain effective internal control over financial reporting in the future, the accuracy and cannot raise it on acceptable terms, if at all,timing of our financial reporting may be adversely affected.
Assessing our processes, procedures and staffing in order to improve our internal control over financial reporting is an ongoing process. Preparing our financial statements involves a number of complex processes, many of which are done manually and are dependent upon individual data input or review. These processes include, but are not limited to, calculating revenue, inventory costs and the preparation of our statement of cash flows. While we may not be ablecontinue to among other things:
human error.
If our estimates or judgments relating to our critical accounting policies are based on assumptions that change or prove to be incorrect or if there is a change in accounting principles, our results of operations could fall below expectations of securities analysts and investors, resulting in a decline in the market price of our common stock.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. WeA change in these principles or interpretations could harm our revenue and financial results, and could affect the reporting of transactions completed before the announcement of a change. In addition, we base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, as described in Part II Item 7 of “Management’s Discussion and Analysis of Financial Condition and Results of Operations,”Operations", in Part II, Item 7, of this Annual Report on Form 10-K, the results of which form the basis for making judgments about the carrying values of assets, liabilities, equity, revenue and expenses that are not readily apparent from other sources. Significant assumptions and estimates used in preparing our consolidated financial statements include those related to revenue recognition, inventory valuation and contract manufacturer/supplier liabilities, income taxes and loss contingencies. If our assumptions change or if actual circumstances differ from those in our assumptions, our results of operations may be adversely affected and may fall below the expectations of securities analysts and investors, resulting in a decline in the market price of our common stock.
There is currently significant uncertainty about the credit risk of our channel partners and some of our end customers, which could result in material losses.
In addition, due to amounts we believeconcerns with the end customers can paysecurity of products and maintain reserves we believe are adequateservices from certain telecommunications and video providers based in China, U.S. Congress has enacted bans on the use of certain Chinese-origin components or systems either in items sold to cover exposure for doubtful accounts. We are unable to recognize revenue from shipments until the collection of those amounts becomes reasonably assured. Any significant delayU.S. government or default in the collectioninternal networks of significant accounts receivable could resultgovernment contractors and subcontractors (even if those networks are not used for government-related projects). Further, the Chinese Government has responded to these U.S. actions by indicating its intention to develop an unreliable entity list, which may limit the ability of companies on the list to engage in an increased need for usbusiness with Chinese customers.
If tariffs, trade restrictions, or trade barriers remain in place or if new tariffs, trade restrictions, or trade barriers are placed on products such as ours by U.S. or foreign governments, especially China, our costs may increase. We believe we can adjust our supply chain and manufacturing practices to obtain working capital from other sources, possibly on worse terms thanminimize the impact of the tariffs, but our efforts may not be successful, there can be no assurance that we could have negotiated if we had established such working capital resources prior to such delays or defaults. Any significant default could adversely affect our results of operations and delay our ability to recognize revenue.
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tariffs imposed by the U.S., which could adversely affect may also negatively impact our business, financial condition, results of operations and prospects. In addition, a decreasecustomers' sales, thereby causing an indirect negative impact on our own sales. Even in the valueabsence of further tariffs, the U.S. dollar relative to foreign currencies could increase our product and operating costs in foreign locations. Further, an increasing portion of our operating expenses is incurred outside the U.S., is denominated in foreign currencies and is subject to fluctuations due to changes in foreign currency exchange rates. If we are not able to successfully hedge against the risks associated with the currency fluctuations, our business, financial condition, results of operations and prospects could be adversely affected.
Given the relatively fluid regulatory environment in China and the United States and uncertainty how the U.S. government or foreign governments will act with respect to tariffs, international trade agreements and policies, a trade war, further governmental action related to tariffs or international trade policies, or additional tax or other regulatory changes in the future could in turn materially affectdirectly and adversely impact our financial condition, results of operations and prospects. For example, in the event our service providers’ information technology systems or manufacturing or logistics abilities are hindered by any of the events discussed above, shipments could be delayed, which could result in missed financial targets, such as revenue and shipment targets, for a particular quarter. Further, if a natural disaster occurs in a region from which we derive a significant portion of our revenue, end customers in that region may delay or forego purchases of our products, which may materially and adversely affect our business, financial condition, results of operations and prospects. In addition, acts of terrorism could cause disruptions in our business or the business of our manufacturers, logistics providers, partners or end customers or the economy as a whole. Given our typical concentration of sales at each quarter end, any disruption in the business of our manufacturers, logistics providers, partners or end customers that affects sales at the end of our quarter could have a particularly significant adverse effect on our quarterly results. All of the aforementioned risks may be augmented if our disaster recovery plans and those of our manufacturers, logistics providers or partners prove to be inadequate. To the extent that any of the above results in delays or cancellations of end-customer orders, or delays in the manufacture, deployment or shipment of our products, our business, financial condition, results of operations and prospects would be adversely affected.
Changes in our income taxes or our effective tax rate, the enactment of new tax laws or changes in the application of existing tax laws of various jurisdictions or adverse outcomes resulting from examination of our income tax returns could adversely affect our results.
Our income taxes are subject to volatility and could be adversely affected by several factors, many of which are outside of our control, including earnings that are lower than anticipated in countries that have lower tax rates and higher than anticipated in countries that have higher tax rates; our ability to generate and use tax attributes; changes in the valuation of our deferred tax assets and liabilities; expiration of or lapses in the federal research and development (“R&D”) tax credit laws; transfer pricing adjustments, including the effect of acquisitions on our inter-company R&D cost sharing arrangement and legal structure;adjustments; tax effects of nondeductible compensation, including certain stock-based compensation; tax costs related to inter-company realignments; changes in accounting principles; adverse tax consequences, including imposition of withholding or other taxes on payments by subsidiaries or customers; or a change in our decision to indefinitely reinvest certain foreign earnings or changes in tax laws and regulations, including the Tax Act enacted on December 22, 2017 and the new U.S. changes to the taxation of earnings of our foreign subsidiaries.
earnings.
Significant judgment is required to evaluate our tax positions and determine our income taxes.tax liability. The accounting guidance for uncertainty in income taxes applies to all income tax positions, including the potential recovery of previously paid taxes, which if settled unfavorably could adversely affect income taxes or additional paid-in capital. In addition, tax laws are dynamic and subject to change as evidenced by the Tax Act. As newchange. Changes in tax laws are passed and newregulations and interpretations of the law are issued or applied, our income taxes may be affected. Recent changes to U.S. taxsuch laws and regulations, including taxation of earnings outside of the U.S., the introduction of a base erosion anti-abuse tax and the disallowance of tax deductions for certain book expense, as well as changes to U.S. tax laws that may be enacted in the future, could impact the tax treatment of our earnings as well asand cash and cash equivalent balances we currently maintain. For example, the Ninth Circuit Court of Appeals, or the Court, is expected to issue an opinion in Altera Corp. v. Commissioner that addresses the treatment of stock-based compensation under a cost-sharing arrangement. We are monitoring this case and any impact the final opinion could have on our financial statements and effective tax rate. Furthermore, due to shifting economic and political conditions, tax policies or rates in various jurisdictions, including the United States, may be subject to significant change.
Failure to comply with governmental laws and regulations could harm our business, financial condition, results of operations and prospects.
Our business is subject to regulation by various federal, state, local and foreign governmental agencies, including agencies responsible for monitoring and enforcing employment and labor laws, workplace safety, product safety, environmental laws, consumer protection laws, privacy, data protection, anti-bribery laws, import/export controls, conflict minerals, federal securities laws and tax laws and regulations. In certain jurisdictions, these regulatory requirements may be more stringent than those in the United States. For example, the European Union, or EU has now implemented the General Data Protection Regulation (“GDPR”). The GDPR requiresprovides for substantial changesobligations relating to the handling, storage and storageother processing of data relating to individuals and administrative fines for violations, which can be up four percent of the previous year’s annual revenue or €20 million, whichever is higher. We have relied on the E.U.-U.S. and Swiss-U.S. Privacy Shield programs, and the use of model contractual clauses approved by the E.U. Commission, to legitimize these transfers. Both the E.U.-U.S. Privacy Shield and these model
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contractual clauses have been subject to legal challenge. We continue to analyze the July 2020 “Schrems II” decision by the Court of Justice of the European Union and its impact on our data transfer mechanisms as well as subsequent guidance from data privacy regulators. The effects of this decision are uncertain and difficult to predict. Among other effects, we may experience additional costs associated with increased compliance burdens and new contract negotiations with third parties that aid in processing data on our behalf. We may experience reluctance or refusal by current or prospective European customers to use our products, and we may find it necessary or desirable to make further changes to our handling of personal data of residents of the European Economic Area (“EEA”). The regulatory environment applicable to the handling of EEA residents’ personal data, and our actions taken in response, may cause us to assume additional liabilities or incur additional costs and could result in our business, operating results and financial condition being harmed. Additionally, we and our customers may face a risk of enforcement actions by data protection authorities in the EEA relating to personal data transfers to us and by us from the EEA. Any such enforcement actions could result in substantial costs and diversion of resources, distract management and technical personnel and negatively affect our business, operating results, and financial condition. Further, the UK has implemented legislation that substantially provides for the GDPR, which provides for fines of up to the greater of 17.5 million British Pounds or four percent of the previous year’s annual revenue, whichever is higher. The relationship between the UK and the EU in relation to certain aspects of data protection law remains unclear following the UK’s exit from the EU, including with respect to regulation of data transfers between EU member states and the UK.
Several jurisdictions have passed new laws and regulations relating to privacy, data protection, and other matters, and other jurisdictions are considering imposing additional restrictions. These laws continue to develop and may be inconsistent from jurisdiction to jurisdiction. For example, the California Consumer Privacy Act (“CCPA”) became operative on January 1, 2020. The CCPA requires covered companies to, among other things, provide new disclosures to California consumers, and affords such consumers new abilities to opt-out of certain sales of personal information. Certain aspects of the CCPA and its interpretation remain uncertain and are likely to remain uncertain for an extended period. Further, a new privacy law, the California Privacy Rights Act (“CPRA”), was approved by the votes in the November 3, 2020 election. The CPRA modifies the CCPA significantly, creating obligations relating to consumer data beginning on January 1, 2022, with implementing regulations expected on or before July 1, 2022, and enforcement beginning July 1, 2023. Passage of the CPRA has resulted, has resulted in further uncertainty and may require us to incur additional costs and expenses in an effort to comply. In addition, some countries are considering or have enacted legislation requiring local storage and processing of data that could increase the cost and complexity of delivering our services. Accordingly, we cannot predict the full impact of the CCPA, the CPRA or other evolving privacy and data protection obligations on our business or operations. Complying with emerging and changing legal and regulatory requirements relating to privacy, data protection and other matters may cause us to incur costs or require us to change our business practices, which could harm our business, financial condition, results of operations and prospects.
We are also subject to environmental laws and regulations governing the management and disposal of hazardous materials and wastes, including the hazardous material content of our products and laws relating to the collection, recycling and disposal of electrical and electronic equipment. Our failure, or the failure of our partners, including our contract manufacturers, to comply with past, present and future environmental laws could result in fines, penalties, third-party claims, reduced sales of our products, re-engineering our products, substantial product inventory write-offs and reputational damage, any of which could harm our business, financial condition, results of operations and prospects. We also expect that our business will be affected by new environmental laws and regulations on an ongoing basis applicable to us and our partners, including our contract manufacturers. To date, our expenditures for environmental compliance have not had a material effect on our results of operations or cash flows. Although we cannot predict the future effect of such laws or regulations, they will likely result in additional costs or require us to change the content or manufacturing of our products, which could have a material adverse effect on our business, financial condition, results of operations and prospects.
From time to time, we may receive inquiries from such governmental agencies or we may make voluntary disclosures regarding our compliance with applicable governmental regulations or requirements relating to various matters, including import/export controls, federal securities laws and tax laws and regulations which could lead to formal investigations. NoncomplianceActual or alleged noncompliance with applicable governmentlaws, regulations or other governmental requirements could lead to regulatory investigations, enforcement actions, and other proceedings, private claims and litigation, and potentially may subject us to sanctions, mandatory product recalls, enforcement actions, disgorgement
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of profits, fines, damages, civil and criminal penalties or injunctions. If any governmental fines, penalties, or other sanctions are imposed, or if we do not prevail in any possible civil or criminal litigation, our business, financial condition, results of operations and prospects could be materially adversely affected. In addition, responding to any investigation, action or other proceeding will likely result in a significant diversion of management’s attention and resources and an increase in professional fees. Enforcement actions, investigations, and fines, penalties, and other sanctions could harm our business, financial condition, results of operations and prospects.
We are subject to governmental export and import controls that could impair our ability to compete in international markets or subject us to liability if we violate these controls.
Our products may be subject to various export controls and because we incorporate encryption technology into certain of our products, certain of our products may be exported from various countries only with the required export license or through an export license exception. If we were to fail to comply with the applicable export control laws, customs regulations, economic sanctions or other applicable laws, we could be subject to monetary damages or the imposition of restrictions which could be material to our business, operating results and prospects and could also harm our reputation. Further, there could be criminal penalties for knowing or willful violations, including incarceration for culpable employees and managers. Obtaining the necessary export license or other authorization for a particular sale may be time-consuming and may result in the delay or loss of sales opportunities. Furthermore, certain export control and economic sanctions laws prohibit the shipment of certain products, technology, software and services to embargoed countries and sanctioned governments, entities, and persons. Even though we take precautions to ensure that we and our channel partners comply with all relevant regulations, any
failure by us or our channel partners to comply with such regulations could have negative consequences, including reputational harm, government investigations and penalties.
As our company grows, we also continue developing procedures and controls to comply with export control and other applicable laws. Historically, we have had some instances where we inadvertently have not fully complied with certain export control laws, but we have disclosed them to, and implemented corrective actions with, the appropriate government agencies.
In addition, various countries regulate the import of certain encryption technology, including through import permit and license requirements, and have enacted laws that could limit our ability to distribute our products or could limit our end customers’ ability to implement our products in those countries. Any change in export or import regulations, economic sanctions or related legislation, shift in the enforcement or scope of existing regulations or change in the countries, governments, persons or technologies targeted by such regulations could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential end customers with international operations or create delays in the introduction of our products into international markets. Any decreased use of our products or limitation on our ability to export or sell our products could adversely affect our business, financial condition, results of operations and prospects.
Risks Related to the Securities Markets and Ownership of Our Common Stock
The trading price of our common stock has been and may continue to be volatile, and the value of your investment could decline.
The trading price of our common stock has historically been and is likely to continue to be volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. These fluctuations could cause you to lose all or part of your investment in our common stock. Factors that could cause fluctuations in the market price of our common stock include, the following:
but are not limited to, forward-looking statements related to future revenue, gross margins and earnings per share;
manufacturing, supply or distribution shortages or constraints, ratings changes by securities analysts, actual or challenges with adding or changing our manufacturing process or supply chain;
our competitors, litigation, actual or anticipated changes or fluctuations in our results of operations;
regulatory developments, in the U.S., foreign countries or both;
stock, departures of key personnel.executives, major catastrophic events, and broad market and industry fluctuations.
In addition, technology stocks have historically experienced high levels of volatility and, if the market for technology stocks or the stock market in general experiences a loss of investor confidence, the market price of our common stock could decline for reasons unrelated to our business, financial condition, results of operations and prospects. The market price of our common stock might also decline in reaction to events that affect other companies in our industry even if these events do not directly affect us. In the past, following periods of volatility in
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the market price of a company’s securities, securities class action litigation has often been brought against that company. If the market price of our common stock is volatile, we may become the target of securities litigation. Securities litigation could result in substantial costs and divert our management’s attention and resources from our business and prospects. This could have a material adverse effect on our business, financial condition, results of operations and prospects.
We have adopted a stock repurchase program to repurchase shares of our common stock, however, any future decisions to reduce or discontinue repurchasing our common stock pursuant to our stock repurchase program could cause the market price for our common stock to decline.
Although our board of directors has authorized a share repurchase program, any determination to execute our stock repurchase program will be subject to, among other things, our financial position and results of operations, available cash and cash flow, capital requirements, and other factors, as well as our board of director’s continuing determination that the repurchase program is in the best interests of our shareholders and is in compliance with all laws and agreements applicable to the repurchase program. Our stock repurchase program does not obligate us to acquire any common stock. If we fail to meet any expectations related to stock repurchases, the market price of our common stock could decline, and could have a material adverse impact on investor confidence. Additionally, price volatility of our common stock over a given period may cause the average price at which we repurchase our common stock to exceed the stock’s market price at a given point in time.
We may further increase or decrease the amount of repurchases of our common stock in the future. Any reduction or discontinuance by us of repurchases of our common stock pursuant to our current share repurchase authorization program could cause the market price of our common stock to decline. Moreover, in the event repurchases of our common stock are reduced or discontinued, our failure or inability to resume repurchasing common stock at historical levels could result in a lower market valuation of our common stock.
Sales of substantial amounts of our common stock in the public markets, or the perception that such sales might occur, could reduce the market price that our common stock might otherwise attain and may dilute your voting power and your ownership interest in us.
Sales of a substantial number of shares of our common stock in the public market, or the perception that such sales could occur, could adversely affect the market price of our common stock and may make it more difficult for you to sell your common stock at a time and price that you deem appropriate and may dilute your voting power and your ownership interest in us.
Based on shares outstanding as of December 31, 2018,2020, holders of approximately 24.0%21.9 % of our common stock have rights, subject to some conditions, to require us to file registration statements covering the sale of their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. In addition, we have registered the offer and sale of all shares of common stock that we may issue under our equity compensation plans. If holders, by exercising their registration rights, sell large numbers of shares, it could adversely affect the market price of our common stock.
Insiders have substantial control over us, which could limit your ability to influence the outcome of key transactions, including a change of control.
Our directors, executive officers and each of our stockholders who own greater than 10% of our outstanding common stock together with their affiliates, in the aggregate, beneficially own approximately 23.2%21.8% of the outstanding shares of our common stock, based on shares outstanding as of December 31, 2018.2020. As a result, these stockholders, if acting together, could exercise a significant level of influence over matters requiring approval by our stockholders, including the election of directors and the approval of mergers, acquisitions or other extraordinary transactions. They may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. This concentration of ownership may also discourage a potential investor from acquiring our common stock due to the limited voting power of such stock or otherwise may have the effect of delaying, preventing or deterring a change of control of our company, could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of our company and might ultimately affect the market price of our common stock.
Our charter documents and Delaware law could discourage takeover attempts and lead to management entrenchment.
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Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that could delay or prevent a change in control of our company. These provisions could also make it difficult for stockholders to elect directors that are not nominated by the current members of our board of directors or take other corporate actions, including effecting changes in our management. These provisions include:
•a classified board of directors with three-year staggered terms, which could delay the ability of stockholders to change the membership of a majority of our board of directors;
•the ability of our board of directors to issue shares of preferred stock and to determine the price and other terms of those shares, including preferences and voting rights, without stockholder approval, which could be used to significantly dilute the ownership of a hostile acquirer;
•the exclusive right of our board of directors to elect a director to fill a vacancy created by the expansion of our board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors;
•a prohibition on stockholder action by written consent, which forces stockholder action to be taken at an annual or special meeting of our stockholders;
•the requirement that a special meeting of stockholders may be called only by the chairman of our board of directors, our president, our secretary or a majority vote of our board of directors, which could delay the ability of our stockholders to force consideration of a proposal or to take action, including the removal of directors;
•the requirement for the affirmative vote of holders of at least 66 2/3% of the voting power of all of the then outstanding shares of the voting stock, voting together as a single class, to amend the provisions of our amended and restated certificate of incorporation relating to the issuance of preferred stock and management of our business or our amended and restated bylaws, which may inhibit the ability of an acquirer to effect such amendments to facilitate an unsolicited takeover attempt;
•the ability of our board of directors, by majority vote, to amend the bylaws, which may allow our board of directors to take additional actions to prevent an unsolicited takeover and inhibit the ability of an acquirer to amend the bylaws to facilitate an unsolicited takeover attempt; and
•advance notice procedures with which stockholders must comply to nominate candidates to our board of directors or to propose matters to be acted upon at a stockholders’ meeting, which may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer’s own slate of directors or otherwise attempting to obtain control of us.
In addition, as a Delaware corporation, we are subject to Section 203 of the Delaware General Corporation Law. These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us for a certain period of time.
If we are unable to hire, retain, train and motivate qualified personnel and senior management, our business, financial condition, results of additional stockoperations and prospects could suffer.
Our future success depends, in part, on our ability to continue to attract and retain highly skilled personnel, particularly software engineering and sales personnel. In addition, our success in expanding into adjacent markets including the enterprise market requires a significant investment of time, effort and financial resources into hiring and training our sales force to address these markets. If we do not effectively train our direct sales force, we may be unable to add new end customers, increase sales to our existing end customers, and successfully expand into new markets.Competition for highly skilled personnel is often intense, especially in the San Francisco Bay Area where we have a substantial presence and need for highly skilled personnel. Many of the companies with which we compete for experienced personnel have greater resources than we have to provide more attractive compensation packages and other amenities. Research and development personnel are aggressively recruited by startup and growth companies, which are especially active in many of the technical areas and geographic regions in which we conduct product development. In addition, in making employment decisions, particularly in the high-technology industry, job candidates often consider the value of the stock-based compensation they are to receive in connection with financings, acquisitions, investments, our stock incentive plans or otherwise will dilute all other stockholders.
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contributions of our senior management to execute our business plan and to identify and pursue new opportunities and product innovations. Our employment arrangements with our employees do not generally require that they continue to work for us for any specified period, and therefore, they could terminate their employment with us at any time. If we are unable to attract or retain qualified personnel, or if there are delays in hiring required personnel, our business, financial condition, results of operations and prospects may be seriously harmed.
Our business is subject to the risks of earthquakes, fire, power outages, floods, health epidemics and other catastrophic events and to interruption by man-made problems such as terrorism.
Our corporate headquarters and the operations of our key manufacturing vendors, logistics providers and partners, as well as many of our customers, are located in areas exposed to risks of natural disasters such as earthquakes and tsunamis, including the San Francisco Bay Area, Japan and Taiwan. A significant natural disaster, such as an earthquake, tsunami, fire or a flood, or other catastrophic event such as the COVID-19 pandemic or other disease outbreak, could have a material adverse effect on our or their business, which could in turn materially affect our financial condition, results of operations and prospects. These events could result in substantial dilutionmanufacturing and supply chain disruptions, shipment delays, order cancellations, and sales delays which could result in missed financial targets. Any health epidemic could have a material adverse effect on our ability to obtain components for our existing stockholdersproducts that are supplied from Asia or to manufacture our products in Asia. Any such disruption of our suppliers, our contract manufacturers or our service providers would likely impact our sales and operating results. In addition, a health epidemic could adversely affect the economies of many countries, resulting in an economic downturn that could affect demand for our products and likely impact our operating results. In addition, acts of terrorism could cause disruptions in our business or the business of our manufacturers, logistics providers, partners or end customers or the economy as a whole. Given our typical concentration of sales at each quarter end, any disruption in the business of our manufacturers, logistics providers, partners or end customers that affects sales at the end of our quarter could have a particularly significant adverse effect on our quarterly results.
We have not paid dividends in the past and do not intend to pay dividends for the foreseeable future.
We have never declared nor paid any dividends on our common stock, and we do not anticipate paying any cash dividends in the future. As a result, you may only receive a return on your investment in our common stock if the market price of our common stock to decline.increases.
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Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our corporate headquarters is located in Santa Clara, California where we currently lease approximately 210,000 square feet of space under a lease agreement that expires in 2023. In addition, we lease office spaces for operations, sales personnel and research and development in locations throughout the U.S. and various international
locations, including Ireland, Canada, India, Australia, the United Kingdom, Korea, Singapore, Japan, Malaysia, China, Mexico, France, Taiwan, and United Arab Emirates.Australia. We also lease data centers in the U.S., Ireland, Australia and the United Kingdom.
We believe that our current facilities are adequate to meet our current needs. We intend to expandneeds and are being utilized by our facilities or add new facilities as we add employees and enter new geographic markets, and we believe that suitable additional or alternative space will be available as needed to accommodate ongoing operations and any such growth. We expect to incur additional expenses in connection with such new or expanded facilities.business.
Item 3. Legal Proceedings
The information set forth under the “Legal Proceedings” in Note 7. Commitments and Contingencies of the Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K is incorporated herein by reference.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Market Information
Our common stock is listed on the NYSE under the symbol “ANET”. As of February 8, 2019,12, 2021, there were 7861 holders of record of our common stock. Because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders.
Stock Performance Graph
The following shall not be deemed “filed” for purposes of Section 18 of the Exchange Act, or incorporated by reference into any of our other filings under the Exchange Act or the Securities Act, except to the extent we specifically incorporate it by reference into such filing.
The following graph compares the cumulative total return of our common stock with the total return for the NYSE Composite Index and the Standard & Poor’s 500 Index (the “S&P 500”) from June 6, 2014 (the date of our initial public offering) through December 31, 2018. 2015 to December 31, 2020.
The graph assumes that $100 was invested at the market close on June 6, 2014's closing priceDecember 31, 2015 (the last trading day of the year) in ourthe Company’s common stock and in each of the NYSE Composite Index andaforementioned indices with the S&P 500, and assumes reinvestmentre-investment of any dividends.dividends, if any. The stock price performance on the following graph is not necessarily indicative of future stock price performance.
Securities Authorized for Issuance Under Equity Compensation Plans
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Recent Sales of Unregistered Equity Securities Act
There were no sales of 1933, as amended (the “Securities Act”). Such shares were issued in a private placement exempt from the registration requirements of the Securities Act, in reliance upon Section 4(a)(2) of the Securities Act or Regulation D or Regulation S promulgated thereunder. The recipients of theunregistered securities in each of these transactions represented their intentions to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof, and appropriate legends were placed upon the share certificates issued in these transactions.during fiscal year 2020.
Issuer Repurchases of Equity Securities
Under our equity incentive plans, certain participants may exercise options prior to vesting, subject to a right of a repurchase by us. During the fourth quarter of 2018,2020, there were no repurchases of unvested shares of our common stock made pursuant to our equity incentive plans as a result of us exercising our rights nor pursuant to any publicly - announced plan or program.
Stock Repurchase Program
In April 2019, our board of directors authorized a $1.0 billion stock repurchase program (the “Repurchase Program”). This authorization allows us to repurchase shares of our common stock over three years and will be funded from operating cash flows. Repurchases may be made at management’s discretion from time to time on the open market, through privately negotiated transactions, transactions structured through investment banking institutions, block purchases, trading plans under Rule 10b5-1 of the Exchange Act, or a combination of the foregoing. The Repurchase Program, which expires in April 2022, does not obligate us to acquire any of our common stock, and may be suspended or discontinued by us at any time without prior notice. We did not make any repurchases for the three months ended December 31, 2020, as disclosed in the table below (in thousands, except per share amounts). For our repurchase activities made during the rest of the year ended December 31, 2020, please refer to Note 8. Stockholders' Equity and Stock-Based Compensation of the Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K.
| Total Number of Shares Purchased | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Approximate Dollar Value of Shares That May Yet Be Purchased Under the Publicly Announced Plans or Programs | |||||||||||||||||||||||
| October 1, 2020 - October 31, 2020 | — | $ | — | — | $ | 338,685 | ||||||||||||||||||||
| November 1, 2020 - November 30, 2020 | — | — | — | 338,685 | ||||||||||||||||||||||
| December 1, 2020 - December 31, 2020 | — | — | — | 338,685 | ||||||||||||||||||||||
Item 6. Selected Consolidated Financial Data
The selected consolidated statements of operations data for fiscal 2018, 20172020, 2019 and 20162018, and the consolidated balance sheet data as of December 31, 20182020 and 20172019 are derived from our audited financial statements appearing in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K. The selected consolidated statements of operations data for fiscal 20152017 and 20142016, and the consolidated balance sheet data as of December 31, 2016, 20152018, 2017 and 20142016, are derived from audited financial statements not included in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of the results to be expected in the future. The following selected consolidated financial data should be read in conjunction with Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,”, our consolidated financial statements, and the accompanying notes appearing in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K to fully understand factors that may affect the comparability of the information presented below.
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| Year Ended December 31, | Year Ended December 31, | |||||||||||||||||||||||||||||||||||||||||||||||||||
| 2018 | 2017 | 2016 | 2015 | 2014 | 2020 | 2019 | 2018 | 2017 | 2016 | |||||||||||||||||||||||||||||||||||||||||||
| (in thousands, except per share data) | (in thousands, except per share data) | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Consolidated Statements of Operations Data: | Consolidated Statements of Operations Data: | Consolidated Statements of Operations Data: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Revenue | $ | 2,151,369 | $ | 1,646,186 | $ | 1,129,167 | $ | 837,591 | $ | 584,106 | Revenue | $ | 2,317,512 | $ | 2,410,706 | $ | 2,151,369 | $ | 1,646,186 | $ | 1,129,167 | |||||||||||||||||||||||||||||||
Cost of revenue (1) | 777,992 | 584,417 | 406,051 | 294,031 | 192,015 | Cost of revenue (1) | 835,626 | 866,368 | 777,992 | 584,417 | 406,051 | |||||||||||||||||||||||||||||||||||||||||
| Total gross profit | 1,373,377 | 1,061,769 | 723,116 | 543,560 | 392,091 | Total gross profit | 1,481,886 | 1,544,338 | 1,373,377 | 1,061,769 | 723,116 | |||||||||||||||||||||||||||||||||||||||||
Operating expenses (1): | Operating expenses (1): | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Research and development | 442,468 | 349,594 | 273,581 | 209,448 | 148,909 | Research and development | 486,594 | 462,759 | 442,468 | 349,594 | 273,581 | |||||||||||||||||||||||||||||||||||||||||
| Sales and marketing | 187,142 | 155,105 | 130,887 | 109,084 | 85,338 | Sales and marketing | 229,366 | 213,907 | 187,142 | 155,105 | 130,887 | |||||||||||||||||||||||||||||||||||||||||
| General and administrative | 65,420 | 86,798 | 75,239 | 75,720 | 32,331 | General and administrative | 66,242 | 61,898 | 65,420 | 86,798 | 75,239 | |||||||||||||||||||||||||||||||||||||||||
Legal settlement (2) | 405,000 | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||||||||
| Legal settlement | Legal settlement | — | — | 405,000 | — | — | ||||||||||||||||||||||||||||||||||||||||||||||
| Total operating expenses | 1,100,030 | 591,497 | 479,707 | 394,252 | 266,578 | Total operating expenses | 782,202 | 738,564 | 1,100,030 | 591,497 | 479,707 | |||||||||||||||||||||||||||||||||||||||||
| Income from operations | 273,347 | 470,272 | 243,409 | 149,308 | 125,513 | Income from operations | 699,684 | 805,774 | 273,347 | 470,272 | 243,409 | |||||||||||||||||||||||||||||||||||||||||
| Other income (expense), net: | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest expense | (2,701 | ) | (2,780 | ) | (3,136 | ) | (3,152 | ) | (6,280 | ) | ||||||||||||||||||||||||||||||||||||||||||
| Other income (expense), net | 18,155 | 7,268 | 1,952 | (147 | ) | 2,275 | Other income (expense), net | 39,179 | 56,496 | 15,454 | 4,488 | (1,184) | ||||||||||||||||||||||||||||||||||||||||
| Total other income (expense), net | 15,454 | 4,488 | (1,184 | ) | (3,299 | ) | (4,005 | ) | ||||||||||||||||||||||||||||||||||||||||||||
| Income before income taxes | 288,801 | 474,760 | 242,225 | 146,009 | 121,508 | Income before income taxes | 738,863 | 862,270 | 288,801 | 474,760 | 242,225 | |||||||||||||||||||||||||||||||||||||||||
Provision for (benefit from) income taxes (3) | (39,314 | ) | 51,559 | 58,036 | 24,907 | 34,658 | ||||||||||||||||||||||||||||||||||||||||||||||
| Provision for (benefit from) income taxes | Provision for (benefit from) income taxes | 104,306 | 2,403 | (39,314) | 51,559 | 58,036 | ||||||||||||||||||||||||||||||||||||||||||||||
| Net income | $ | 328,115 | $ | 423,201 | $ | 184,189 | $ | 121,102 | $ | 86,850 | Net income | $ | 634,557 | $ | 859,867 | $ | 328,115 | $ | 423,201 | $ | 184,189 | |||||||||||||||||||||||||||||||
| Net income attributable to common stockholders: | Net income attributable to common stockholders: | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Basic | $ | 327,926 | $ | 422,400 | $ | 182,965 | $ | 119,115 | $ | 68,889 | Basic | 634,557 | 859,444 | 327,926 | 422,400 | 182,965 | ||||||||||||||||||||||||||||||||||||
| Diluted | $ | 327,941 | $ | 422,468 | $ | 183,039 | $ | 119,264 | $ | 70,524 | Diluted | 634,557 | 859,468 | 327,941 | 422,468 | 183,039 | ||||||||||||||||||||||||||||||||||||
| Net income per share attributable to common stockholders: | Net income per share attributable to common stockholders: | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Basic | $ | 4.39 | $ | 5.85 | $ | 2.66 | $ | 1.81 | $ | 1.42 | Basic | $ | 8.35 | $ | 11.26 | $ | 4.39 | $ | 5.85 | $ | 2.66 | |||||||||||||||||||||||||||||||
| Diluted | $ | 4.06 | $ | 5.35 | $ | 2.50 | $ | 1.67 | $ | 1.29 | Diluted | $ | 7.99 | $ | 10.63 | $ | 4.06 | $ | 5.35 | $ | 2.50 | |||||||||||||||||||||||||||||||
| Weighted-average shares used in computing net income per share attributable to common stockholders: | Weighted-average shares used in computing net income per share attributable to common stockholders: | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Basic | 74,750 | 72,258 | 68,771 | 65,964 | 48,427 | Basic | 75,984 | 76,312 | 74,750 | 72,258 | 68,771 | |||||||||||||||||||||||||||||||||||||||||
| Diluted | 80,844 | 78,977 | 73,222 | 71,411 | 54,590 | Diluted | 79,465 | 80,879 | 80,844 | 78,977 | 73,222 | |||||||||||||||||||||||||||||||||||||||||
____________________
(1)Includes stock-based compensation expense as follows:
| Year Ended December 31, | ||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2018 | 2017 | 2016 | ||||||||||||||||||||||||||||
| (in thousands) | ||||||||||||||||||||||||||||||||
| Cost of revenue | $ | 6,272 | $ | 4,637 | $ | 5,087 | $ | 4,353 | $ | 3,620 | ||||||||||||||||||||||
| Research and development | 79,913 | 53,068 | 48,205 | 42,184 | 31,892 | |||||||||||||||||||||||||||
| Sales and marketing | 34,944 | 29,168 | 24,995 | 17,953 | 15,666 | |||||||||||||||||||||||||||
| General and administrative | 15,913 | 14,407 | 12,915 | 10,937 | 7,854 | |||||||||||||||||||||||||||
| Total stock-based compensation | $ | 137,042 | $ | 101,280 | $ | 91,202 | $ | 75,427 | $ | 59,032 | ||||||||||||||||||||||
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| Year Ended December 31, | ||||||||||||||||||||
| 2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||||
| (in thousands) | ||||||||||||||||||||
| Cost of revenue | $ | 5,087 | $ | 4,353 | $ | 3,620 | $ | 3,048 | $ | 1,535 | ||||||||||
| Research and development | 48,205 | 42,184 | 31,892 | 25,515 | 14,986 | |||||||||||||||
| Sales and marketing | 24,995 | 17,953 | 15,666 | 11,454 | 7,643 | |||||||||||||||
| General and administrative | 12,915 | 10,937 | 7,854 | 5,286 | 3,455 | |||||||||||||||
| Total stock-based compensation | $ | 91,202 | $ | 75,427 | $ | 59,032 | $ | 45,303 | $ | 27,619 | ||||||||||
| December 31, | ||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2018 | 2017 | 2016 | ||||||||||||||||||||||||||||
| (in thousands) | ||||||||||||||||||||||||||||||||
| Consolidated Balance Sheet Data: | ||||||||||||||||||||||||||||||||
| Cash, cash equivalents and marketable securities | $ | 2,872,868 | $ | 2,724,368 | $ | 1,956,147 | $ | 1,535,555 | $ | 867,833 | ||||||||||||||||||||||
| Working capital | 3,068,755 | 2,874,562 | 2,108,298 | 1,736,524 | 1,066,573 | |||||||||||||||||||||||||||
| Total assets | 4,738,919 | 4,185,290 | 3,081,983 | 2,460,860 | 1,729,007 | |||||||||||||||||||||||||||
| Total indebtedness | — | — | 37,743 | 39,592 | 41,210 | |||||||||||||||||||||||||||
Total deferred revenue and customer contract liabilities | 736,784 | 636,338 | 619,822 | 515,262 | 372,935 | |||||||||||||||||||||||||||
| Total stockholders’ equity | 3,320,291 | 2,894,686 | 2,143,389 | 1,661,914 | 1,107,820 | |||||||||||||||||||||||||||
| December 31, | ||||||||||||||||||||
| 2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||||
| (in thousands) | ||||||||||||||||||||
| Consolidated Balance Sheet Data: | ||||||||||||||||||||
| Cash, cash equivalents and marketable securities | $ | 1,956,147 | $ | 1,535,555 | $ | 867,833 | $ | 687,326 | $ | 449,457 | ||||||||||
| Working capital | 2,108,298 | 1,736,524 | 1,066,573 | 739,317 | 535,106 | |||||||||||||||
| Total assets | 3,081,983 | 2,460,860 | 1,729,007 | 1,159,890 | 811,023 | |||||||||||||||
Total indebtedness (1) | 37,743 | 39,592 | 41,210 | 42,546 | 43,634 | |||||||||||||||
Total deferred revenue and customer contract liabilities (2) | 619,822 | 515,262 | 372,935 | 196,808 | 106,468 | |||||||||||||||
| Total stockholders’ equity | $ | 2,143,389 | $ | 1,661,914 | $ | 1,107,820 | $ | 788,152 | $ | 555,658 | ||||||||||
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations together with the consolidated financial statements and related notes that are included elsewhere in this Annual Report on Form 10-K. 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 Annual Report on Form 10-K.
Overview
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, or 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. 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 Facebook in fiscal 2019 collectively represented 40% of our total revenue, whereas sales to our end customer Microsoft in fiscal 2020 amounted to 21.5% of our revenues, with our end customer Facebook representing less than 10% of our revenues in the period. These changes contributed to a year-over-year decline in our revenue for fiscal 2020. However, this decline in revenue from these large end customers was in part 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 believe that cloud networksnetworking will continue to replace legacy network technologies across data center and that ourcampus environments. Our cloud networking platform addressesplatforms are well positioned to address the large and growing cloud networking segment of data center switching, which
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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 growingto evolve and adapt to our organizationrapidly changing environment. We must also continue to meetdevelop 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 to reach new end customers more effectively, increase sales to existing customers, as they increasingly realize the performance and cost benefits of our cloud networking solutionsprovide services and as they expand their cloud networks. Accordingly,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 ofability 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. 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 currently procure certain merchant silicon components from multiple vendors, and we continue to expand our relationships with these and other vendors. 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.
Recent Developments
The global coronavirus (“COVID-19”) pandemic and related shelter in place, travel and social distancing restrictions imposed by a relatively limited numbergovernments 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 end customersfinancial 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 accounted for significant portiontaken numerous steps, and will continue to take further actions, in our approach to address COVID-19. We have prioritized the protection of our revenue.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 unpredictabilitydelays in component sourcing, workforce disruptions and governmental restrictions on the timingproduction and export of large orders, especially with respecttheir 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 large end customers due to the complexity of orders, the time it takes end customers to evaluate, test, qualify and accept our products and factors specific to our end customers. Due to these factors, we expect continued variability in our customer concentration and timing of sales on a quarterlytimely 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. When the COVID-19 pandemic began, we initially experienced some volatility in customer demand, but sales activity subsequently stabilized and annual basis. For example, our saleswe experienced incremental improvements in overall demand as the year progressed. However, the supply chain disruptions outlined above and the earlier volatility in customer demand contributed in part to Microsoft as an end-usera year-over-year decline in total revenue for the fiscal year ended December 31, 2018, representing 27%2020.
The extent of the impact of COVID-19 on our revenue during fiscal 2018, benefitedoperational 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, the breadth and duration of governmental containment measures such as shelter in place, travel and social distancing restrictions as well as the reauthorization of or increase in such measures in the event of spikes in COVID-19 infection rates, the success of the COVID-19 vaccination deployment, and the impact on our customers, partners, contract manufacturers
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and supply chain, all of which are uncertain and cannot be predicted. However, any continued or renewed disruption in manufacturing and supply resulting from certain factorsthe 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 repeat in fiscal 2019 orbe indicative of future fiscal yearsoperating results and the percentage oftrends.
In response to potential future COVID-19 related disruptions to our revenue from Microsoft in fiscal 2019 may decline. In addition,business, we have provided,continued to carefully review our investment and mayspending plans, cautiously increasing incremental spending in the future provide, pricing discounts to large end customers, which may result in lower margins forsecond half of fiscal 2020 as overall customer demand stabilized. Although management is actively monitoring the period in which such sales occur. Our gross margins may also fluctuate as a resultimpact of COVID-19 on the Company’s financial condition, liquidity, operations, suppliers, industry, and workforce, the full impact of the timingpandemic continues to evolve as of such sales to large end customers.
Acquisitions
On August 2, 2018,February 5, 2020, we acquired Big Switch Networks, Inc. (“Big Switch”), a network monitoring and software-defined networking pioneer headquartered in Santa Clara, California. With the acquisition of Big Switch, we expanded 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. In addition, on October 7, 2020, we completed the acquisition of Mojo Networks,Awake Security Inc. (“Awake Security”), a provider of Cognitive WiFinetwork detection and cloud-managed wireless networking solutionsresponse (“NDR”) platform provider headquartered in Mountain View,Santa Clara, California. We expect to extend our cognitive cloud networking architecture with the addition of Mojo by providing secure, high performance cognitive WiFi at cloud scale.
Results of Operations
Year Ended December 31, 20182020 Compared to Year Ended December 31, 20172019
Revenue, Cost of Revenue and Gross Profit (in thousands, except percentages)
| Year Ended December 31, | ||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | Change in | ||||||||||||||||||||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ | % | |||||||||||||||||||||||||||||||||
| Revenue | ||||||||||||||||||||||||||||||||||||||
| Product | $ | 1,830,842 | 79.0 | % | $ | 2,021,150 | 83.8 | % | $ | (190,308) | (9.4) | % | ||||||||||||||||||||||||||
| Service | 486,670 | 21.0 | 389,556 | 16.2 | 97,114 | 24.9 | ||||||||||||||||||||||||||||||||
| Total revenue | 2,317,512 | 100.0 | 2,410,706 | 100.0 | (93,194) | (3.9) | ||||||||||||||||||||||||||||||||
| Cost of revenue | ||||||||||||||||||||||||||||||||||||||
| Product | 749,962 | 32.4 | 792,382 | 32.9 | (42,420) | (5.4) | ||||||||||||||||||||||||||||||||
| Service | 85,664 | 3.7 | 73,986 | 3.0 | 11,678 | 15.8 | ||||||||||||||||||||||||||||||||
| Total cost of revenue | 835,626 | 36.1 | 866,368 | 35.9 | (30,742) | (3.5) | ||||||||||||||||||||||||||||||||
| Gross profit | $ | 1,481,886 | 63.9 | % | $ | 1,544,338 | 64.1 | % | $ | (62,452) | (4.0) | % | ||||||||||||||||||||||||||
| Gross margin | 63.9 | % | 64.1 | % | ||||||||||||||||||||||||||||||||||
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| Year Ended December 31, | |||||||||||||||||||||
| 2018 | 2017 | Change in | |||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ | % | ||||||||||||||||
| Revenue | |||||||||||||||||||||
| Product | $ | 1,841,100 | 85.6 | % | $ | 1,432,810 | 87.0 | % | $ | 408,290 | 28.5 | % | |||||||||
| Service | 310,269 | 14.4 | 213,376 | 13.0 | 96,893 | 45.4 | |||||||||||||||
| Total revenue | 2,151,369 | 100.0 | 1,646,186 | 100.0 | 505,183 | 30.7 | |||||||||||||||
| Cost of revenue | |||||||||||||||||||||
| Product | 720,584 | 33.5 | 538,035 | 32.7 | 182,549 | 33.9 | |||||||||||||||
| Service | 57,408 | 2.7 | 46,382 | 2.8 | 11,026 | 23.8 | |||||||||||||||
| Total cost of revenue | 777,992 | 36.2 | 584,417 | 35.5 | 193,575 | 33.1 | |||||||||||||||
| Gross profit | $ | 1,373,377 | 63.8 | % | $ | 1,061,769 | 64.5 | % | $ | 311,608 | 29.3 | % | |||||||||
| Gross margin | 63.8 | % | 64.5 | % | |||||||||||||||||
Revenue by Geography (in thousands, except percentages)
| Year Ended December 31, | Year Ended December 31, | |||||||||||||||||||||||||||||||||||||||
| 2018 | % of Total | 2017 | % of Total | 2020 | % of Total | 2019 | % of Total | |||||||||||||||||||||||||||||||||
| Americas | $ | 1,550,453 | 72.1 | % | $ | 1,192,289 | 72.4 | % | Americas | $ | 1,771,992 | 76.5 | % | $ | 1,833,163 | 76.1 | % | |||||||||||||||||||||||
| Europe, Middle East and Africa | 414,069 | 19.2 | 299,547 | 18.2 | Europe, Middle East and Africa | 326,729 | 14.1 | 381,651 | 15.8 | |||||||||||||||||||||||||||||||
| Asia-Pacific | 186,847 | 8.7 | 154,350 | 9.4 | Asia-Pacific | 218,791 | 9.4 | 195,892 | 8.1 | |||||||||||||||||||||||||||||||
| Total revenue | $ | 2,151,369 | 100.0 | % | $ | 1,646,186 | 100.0 | % | Total revenue | $ | 2,317,512 | 100.0 | % | $ | 2,410,706 | 100.0 | % | |||||||||||||||||||||||
Revenue
Product revenue increased $408.3decreased $190.3 million, or 28.5%9.4%, in the year ended December 31, 20182020 compared to 2017.2019. The increasedecrease was primarily driven by salesdue to our existing customers as they continued to expand and upgrade their cloud networks. In addition, our newer switch products have continued to gain market acceptance, which has contributed to ourthe recognition of $125.1 million of deferred product revenue growth. Service revenue increased $96.9 million, or 45.4%, in the year ended December 31, 20182019 related to customer acceptance of products shipped in prior periods. In addition, we experienced reduced sales to our larger customers during fiscal 2020, combined with the impact of some COVID-19 related supply constraints. Service revenue increased $97.1 million, or 24.9% in the year ended December 31, 2020 compared to 20172019 as a result of continued growth in initial and renewal support contracts as our customer installed base has continued to expand. We continueInternational revenues remained relatively constant at 23.5% of total revenues in the year ended December 31, 2020, compared to experience pricing pressure on our products and services due to competition, but demand for our products and23.9% in 2019, with a slight decrease in growth in our installed base has more thanEMEA region, mostly offset this pricing pressure duringby an increase in growth in our Asia-Pacific region. International revenue generally fluctuates based on the period.timing of deployments by certain of our large end customers.
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 inof our manufacturing operations, department, and other manufacturing-related costs associated with manufacturing our products and managing our inventory. Cost of service revenue primarily consists of personnel and other costs associated with our global customer support and services organizations.
Cost of revenue increased $193.6decreased $30.7 million or 33.1%3.5% for the year ended December 31, 20182020 compared to 2017.2019. The increasedecrease in cost of revenue was primarily due to thea corresponding increasesdecrease in product revenues. We expect our cost ofrevenues, and was partially offset by incremental COVID-19 related supply chain costs and increased product revenue to continue to increase as our product revenue increases. Cost of providing PCS and other services consists primarily of personnel costs for our global customer support organization.transition costs.
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, manufacturing-related costs, including costs associated with supply chain sourcing activities, merchant silicon costs, the mix of products sold, and excess/obsolete inventory write-downs, including charges for excess/obsolete component inventory held by our contract manufacturers.
Gross margin slightly decreased from 64.1% for the year ended December 31, 2019 to 63.9% in 2020. Gross margin was negatively impacted by incremental COVID-19 related supply chain costs and some increased product transition costs, combined with the impact of fixed overhead costs on a lower revenue base. These negative impacts were partially offset by a reduction in sales to our larger end customers who generally receive larger discounts, and improved service margins as we scale our services organization.
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Operating Expenses (in thousands, except percentages)
Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses, and legal settlement expense.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. We
| Year Ended December 31, | Year Ended December 31, | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2018 | 2017 | Change in | 2020 | 2019 | Change in | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ | % | $ | % of Revenue | $ | % of Revenue | $ | % | ||||||||||||||||||||||||||||||||||||||||||||||||
| Operating expenses: | Operating expenses: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Research and development | $ | 442,468 | 20.6 | % | $ | 349,594 | 21.2 | % | $ | 92,874 | 26.6 | % | Research and development | $ | 486,594 | 20.9 | % | $ | 462,759 | 19.2 | % | $ | 23,835 | 5.2 | % | ||||||||||||||||||||||||||||||||||
| Sales and marketing | 187,142 | 8.7 | 155,105 | 9.4 | 32,037 | 20.7 | Sales and marketing | 229,366 | 9.9 | 213,907 | 8.9 | 15,459 | 7.2 | ||||||||||||||||||||||||||||||||||||||||||||||
| General and administrative | 65,420 | 3.0 | 86,798 | 5.3 | (21,378 | ) | (24.6 | ) | General and administrative | 66,242 | 2.9 | 61,898 | 2.6 | 4,344 | 7.0 | ||||||||||||||||||||||||||||||||||||||||||||
| Legal settlement | 405,000 | 18.8 | — | — | 405,000 | * | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total operating expenses | $ | 1,100,030 | 51.1 | % | $ | 591,497 | 35.9 | % | $ | 508,533 | 86.0 | % | Total operating expenses | $ | 782,202 | 33.7 | % | $ | 738,564 | 30.7 | % | $ | 43,638 | 5.9 | % | ||||||||||||||||||||||||||||||||||
| __________________ | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| * Not meaningful. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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.costs. Our research and development efforts are focused on new product development and 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 expect our research and development expenses to increase in absolute dollars as we continue to invest heavily in software development in order to expand the capabilities of our cloud networking platform, introduce new products and features, and build upon our technology leadership.
Research and development expenses increased $92.9$23.8 million, or 26.6%5.2%, for the year ended December 31, 20182020 compared to 2017.2019. The increase was primarily due to a $48.9$26.8 million increase in personnel costs, including corporate bonuses and stock-based compensation driven primarily by headcount growthfrom new and refresh grants during the current fiscal year, and a $7.8 million increase in acquisition-related expenses and amortization of acquired intangible assets from our normal hiring processacquisition of Big Switch and from the two acquisitions we completed in the third quarter of 2018, and a $24.7Awake Security, partially offset by an $11.4 million increasedecrease in new product introduction costs, driven by additionalincluding third-party engineering and other product development projects. In addition, facility and IT costs increased by $9.5 million due to increased IT services, headcount growth and additional costs associated with our acquired businesses.costs.
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.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 $32.0$15.5 million, or 20.7%7.2%, for the year ended December 31, 20182020 compared to 2017.2019. The increase primarily included a $28.0 million increase in personnel costs, which was driven by increased headcount, as well as higher sales volumes, resulting in increased compensation costs, including commissionssalaries and stock-based compensation.compensation, partially offset by a decrease in travel and other sales and marketing activities due to COVID-19.
General and administrative.
General and administrative expenses consist primarily of Cisco and OptumSoft litigation related expenses, personnel costs and professional services fees, and an allocated portion of facility and IT costs including depreciation.costs. General and administrative personnel costs include those for our executive, finance, human resources and legal functions. Our professional services feescosts are primarily duerelated to external legal, accounting, and tax services.
General and administrative expenses decreased $21.4increased $4.3 million, or 24.6%7.0%, for the year ended December 31, 20182020 compared to 2017.2019. The decrease included a $33.8 million decrease thatincrease was primarily related to a reduced level of litigation activities and a decrease in bond costs as a result of the settlement of the Cisco litigation in August 2018. The decrease was partially offset by $3.5 million of acquisition-related expenses incurred in 2018,
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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, foreign currency transaction gains and losses, gains and losses on our investments in privately-held companies, and interest expense on our lease financing obligation. In connection with our adoption of ASU 2016-01 in 2018,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 private company equity investments upon the occurrence of observable price changes and/or impairments. See Note 1. Organization and Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K for details of this new guidance. In addition, Other income (expense), net will also fluctuate due toimpairments, changes in interest rates or returns on our cash and cash equivalents and marketable securities, and foreign currency exchange rate fluctuations on our foreign currency transactions.fluctuations.
| Year Ended December 31, | |||||||||||||||||||||
| 2018 | 2017 | Change in | |||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ | % | ||||||||||||||||
| Other income (expense), net: | |||||||||||||||||||||
| Interest expense | $ | (2,701 | ) | (0.1 | )% | $ | (2,780 | ) | (0.2 | )% | $ | 79 | (2.8 | )% | |||||||
| Other income (expense), net | 18,155 | 0.8 | 7,268 | 0.4 | 10,887 | 149.8 | |||||||||||||||
| Total other income (expense), net | $ | 15,454 | 0.7 | % | $ | 4,488 | 0.2 | % | $ | 10,966 | 244.3 | % | |||||||||
| Year Ended December 31, | ||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | Change in | ||||||||||||||||||||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ | % | |||||||||||||||||||||||||||||||||
| Other income, net: | ||||||||||||||||||||||||||||||||||||||
| Interest income | $ | 27,139 | 1.2 | % | $ | 51,144 | 2.2 | % | $ | (24,005) | (46.9) | % | ||||||||||||||||||||||||||
| Gain on sale of marketable securities | 9,432 | 0.4 | — | — | 9,432 | 100.0 | ||||||||||||||||||||||||||||||||
| Gain on investments in privately-held companies | 4,164 | 0.2 | 5,427 | 0.2 | (1,263) | (23.3) | ||||||||||||||||||||||||||||||||
| Other income (expense) | (1,556) | (0.1) | (75) | — | (1,481) | 1,974.7 | ||||||||||||||||||||||||||||||||
| Total other income, net | $ | 39,179 | 1.7 | % | $ | 56,496 | 2.4 | % | $ | (17,317) | (30.7) | % | ||||||||||||||||||||||||||
The favorableunfavorable change in other income, (expense), net, during the year ended December 31, 20182020 as compared to 20172019 was driven by a $23.6$24.0 million increasedecrease in interest income as we continuedlargely due to generate cash and expand ourlower interest rates. This was partially offset by a realized gain of $9.4 million on the sale of marketable securities portfolios, which was offset partially by a $13.8 million net loss recorded in 2018 on our investments in privately-held companies. See Note 5. Investmentsthe third quarter of the Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K for further discussion.year ended December 31, 2020.
Provision for (Benefit from) Income Taxes (in thousands, except percentages)
We operate in a number of tax jurisdictions and are subject to taxes in each country or jurisdiction in which we conduct business. Earnings from our non-U.S. activities are subject to local country income tax and may also be subject to U.S. income tax. Generally, our U.S. tax obligations are reduced by a credit for foreign income taxes paid on these foreign earnings, which avoids double taxation. Our tax expense to date consists of federal, state and foreign current and deferred income taxes.
| Year Ended December 31, | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Year Ended December 31, | 2020 | 2019 | Change in | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2018 | 2017 | Change in | $ | % of Revenue | $ | % of Revenue | $ | % | |||||||||||||||||||||||||||||||||||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Provision for (benefit from) income taxes | $ | (39,314 | ) | (1.9 | )% | $ | 51,559 | 3.1 | % | $ | (90,873 | ) | (176.3 | ) | |||||||||||||||||||||||||||||||||||||||||||||
| Provision for income taxes | Provision for income taxes | $ | 104,306 | 4.5 | % | $ | 2,403 | 0.1 | % | $ | 101,903 | 4,240.7 | |||||||||||||||||||||||||||||||||||||||||||||||
| Effective tax rate | (13.6 | )% | 10.9 | % | Effective tax rate | 14.1 | % | 0.3 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||
For the years ended December 31, 20182020 and 2017,2019, we recorded a benefit of $39.3 million and an expense of $51.6$104.3 million and $2.4 million for income taxes, respectively.respectively, and our effective tax rate increased from 0.3% in 2019 to 14.1% in 2020. The change in our income taxes was largely attributable to a $96.9 millionnet tax benefit on the Cisco settlementof $86 million in 2018 whereas2019 resulting from an intra-entity transaction to sell our non-Americas economic and beneficial intellectual property rights. Further, while we recorded a $51.8 million tax expense in 2017 related to the enactment of the Tax Act. The Tax Act provided forexperienced a decrease in worldwide profit before tax in 2020 compared to 2019, the 2018 U.S. federal statutory tax benefits attributable to stock-based compensation also decreased, along with an increase in foreign earnings taxed in non-zero rate but this was partially offset by a new requirement to provide U.S.jurisdictions, resulting in overall higher tax on foreign earnings.expense. For further information regarding income taxes and the impact on our results of operations and financial position, seerefer to Note 10. Income Taxes of the Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K.
Year Ended December 31, 20172019 Compared to Year Ended December 31, 20162018
Revenue, Cost of Revenue and Gross Profit (in thousands, except percentages)
57
| Year Ended December 31, | Year Ended December 31, | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2017 | 2016 | Change in | 2019 | 2018 | Change in | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ | % | $ | % of Revenue | $ | % of Revenue | $ | % | ||||||||||||||||||||||||||||||||||||||||||||||||
| Revenue | Revenue | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Product | $ | 1,432,810 | 87.0 | % | $ | 991,337 | 87.8 | % | $ | 441,473 | 44.5 | % | Product | $ | 2,021,150 | 83.8 | % | $ | 1,841,100 | 85.6 | % | $ | 180,050 | 9.8 | % | ||||||||||||||||||||||||||||||||||
| Service | 213,376 | 13.0 | 137,830 | 12.2 | 75,546 | 54.8 | Service | 389,556 | 16.2 | 310,269 | 14.4 | 79,287 | 25.6 | ||||||||||||||||||||||||||||||||||||||||||||||
| Total revenue | 1,646,186 | 100.0 | 1,129,167 | 100.0 | 517,019 | 45.8 | Total revenue | 2,410,706 | 100.0 | 2,151,369 | 100.0 | 259,337 | 12.1 | ||||||||||||||||||||||||||||||||||||||||||||||
| Cost of revenue | Cost of revenue | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Product | 538,035 | 32.7 | 369,768 | 32.8 | 168,267 | 45.5 | Product | 792,382 | 32.9 | 720,584 | 33.5 | 71,798 | 10.0 | ||||||||||||||||||||||||||||||||||||||||||||||
| Service | 46,382 | 2.8 | 36,283 | 3.2 | 10,099 | 27.8 | Service | 73,986 | 3.0 | 57,408 | 2.7 | 16,578 | 28.9 | ||||||||||||||||||||||||||||||||||||||||||||||
| Total cost of revenue | 584,417 | 35.5 | 406,051 | 36.0 | 178,366 | 43.9 | Total cost of revenue | 866,368 | 35.9 | 777,992 | 36.2 | 88,376 | 11.4 | ||||||||||||||||||||||||||||||||||||||||||||||
| Gross profit | $ | 1,061,769 | 64.5 | % | $ | 723,116 | 64.0 | % | $ | 338,653 | 46.8 | % | Gross profit | $ | 1,544,338 | 64.1 | % | $ | 1,373,377 | 63.8 | % | $ | 170,961 | 12.4 | % | ||||||||||||||||||||||||||||||||||
| Gross margin | 64.5 | % | 64.0 | % | Gross margin | 64.1 | % | 63.8 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||
Revenue by Geography (in thousands, except percentages)
| Year Ended December 31, | Year Ended December 31, | |||||||||||||||||||||||||||||||||||||||
| 2017 | % of Total | 2016 | % of Total | 2019 | % of Total | 2018 | % of Total | |||||||||||||||||||||||||||||||||
| Americas | $ | 1,192,289 | 72.4 | % | $ | 874,740 | 77.5 | % | Americas | $ | 1,833,163 | 76.1 | % | $ | 1,550,453 | 72.1 | % | |||||||||||||||||||||||
| Europe, Middle East and Africa | 299,547 | 18.2 | 168,789 | 14.9 | Europe, Middle East and Africa | 381,651 | 15.8 | 414,069 | 19.2 | |||||||||||||||||||||||||||||||
| Asia-Pacific | 154,350 | 9.4 | 85,638 | 7.6 | Asia-Pacific | 195,892 | 8.1 | 186,847 | 8.7 | |||||||||||||||||||||||||||||||
| Total revenue | $ | 1,646,186 | 100.0 | % | $ | 1,129,167 | 100.0 | % | Total revenue | $ | 2,410,706 | 100.0 | % | $ | 2,151,369 | 100.0 | % | |||||||||||||||||||||||