Weyco Group Q3 2023 Earnings Call Transcript

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November 9, 2023

There are 7 speakers on the call.

Operator

Was 353, which represents a slight change from 345 team members at the end of Q2 and 360 team members in the same prior year period. In Q3, we posted non GAAP net income of $9,600,000 our non GAAP net income translates to earnings per diluted share of $0.09 a record for Arlo and at the high end of our guidance range. Regarding our balance sheet and liquidity position. We ended the quarter with 120 $6,000,000 in available cash, cash equivalents and short term investments. This balance was up over $2,000,000 sequentially and demonstrates the solid capital position that Arlo is in right now.

Operator

We are pleased to report that we generated approximately $7,000,000 in free cash flow in Q3, which represents free cash flow margin of 5%, an improvement driven by our increased profitability and solid working capital management. Additionally, our year to date free cash flow was a remarkable $28,000,000 throughout the 1st 3 quarters of 2023 or an almost $64,000,000 improvement over the same period last year. Our Q3 inventory balance ended at $53,000,000 up $14,000,000 from Q2 2023 as a result of the launch of our Essential 2 camera portfolio and in line with our expectations. Inventory turns in Q3 were at 5.5x, down from 6.1x in the last quarter. Our new product launch will enable us to remain highly aggressive with our product pricing strategy, particularly through the holiday season and into 2024.

Operator

We remain focused on maintaining appropriate inventory levels to effectuate a smooth product transition with our retailers and partners. These factors have impacted our inventory balance and thereby our ability to generate similar levels of free cash flow. And finally, our accounts receivable balance was $70,000,000 at the quarter end with Q3 DSOs at 49 days, down from 59 days from the same period last year. We will continue to monitor our working capital balances in line with our revenue and forecasted consumer demand levels with a focus on maintaining a solid balance sheet and liquidity position in the future. Now turning to our outlook.

Operator

We expect the 4th quarter revenue for 2023 to be in the range of $129,000,000 to $139,000,000 or $485,000,000 to $495,000,000 for the full year, thereby increasing the midpoint of our full year guidance. We expect our GAAP net income loss per diluted share to be between a loss of 0 point 0 $5 to income of $0.01 per share and our non GAAP net income per diluted share to be between 0 point 0 $6 and $0.12 per share for Q4 2023. Service revenue is still forecasted to grow to only 45% over last year, thereby becoming a much larger portion of our overall revenue and profitability mix, and we expect non GAAP services gross margin to be in the range of 75% for 2023. And now I'll open it up for questions.

Speaker 1

Your first question comes from the line of Scott Searle with ROTH MKM. Your line is open. Scott Searle with MKM, your line is open.

Speaker 2

Hey, good afternoon. Thanks for taking my questions. Nice job on the quarter guys. Hey, Kurt, I apologize bouncing between calls, but I was wondering if you could Talk a little bit about the ARPU mix in the quarter between strategics and otherwise. It looked like it was a little bit down sequentially.

Speaker 2

I'm wondering if there's Anything to read into that in terms of pricing, rebates or otherwise? And how we should expect that to trend over the next couple of quarters?

Operator

Yes. Scott, and welcome to the team. Thanks again for your support and glad to have you on the call today. Great question. We're still very pleased with the way that our ARPU is trending.

Operator

We've communicated in the past that when you look at our retail channel, our ARPU trends in the range of $11.50 which is up year over year driven much because of our pricing strategy that we employed earlier this year. So that's been trending very well. The ARPU on the strategic account side is heavily driven around the actual revenue model. As we've mentioned in the past, it's more of a cost consumption SaaS based pricing type model. So that tends to be lower than our retail channel ARPU, but it's right in line with our expectations.

Operator

What we are seeing though is that in terms of the overall subscriber mix, subscriber mix has been mixing up slightly higher on in the strategic accounts side. So that might have a trend of impacting our overall blended ARPU, but it's still in line with expectations and it's still trending in a favorable way.

Speaker 2

Got you. And just as a follow-up, I'm wondering if you could talk a little bit about attach rates in terms of paid accounts, if we're seeing any sort of Divergence on that front are things are consisting progressing in line with expectations. And I guess as part of that now, the more advanced 20 fourseven secondurity monitoring opportunity for you. I'm wondering How you see that fitting into the picture? What the broad based expectations are for that?

Speaker 2

Thanks.

Speaker 3

Yes. This is Matt. I'm happy to welcome you as well to the call, Got it. From a security perspective, the security system, I mean, we're very excited about that. I'll just kind of reference the announcement we made this morning around the total security subscription Which is really exciting.

Speaker 3

It combines the service and the hardware together in one low monthly payment. We're doing that with our partner Affirm. And that's us positioning the security system, which comes with higher ARPU over time in that relationship in a way that consumers are kind of used to buying that already, especially from a direct customer. So yes, we're very excited about that. I'm trying to remember what was the first part of your question.

Speaker 2

Matt, just in terms of attach rates.

Operator

Attach rates, yes, sorry.

Speaker 3

Yes. So we haven't seen any big changes in attach rates or conversion rates. And just to remind everybody, we actually track both. So attach rates for us is a measure 30 days after the initial trial is done. We take a quick snap and look at the attach rates, and that's roughly 50%.

Speaker 3

And then we continue to follow those cohorts all the way up to 6 months at later. And that's what we call our conversion rate. Both of those metrics, and I will even add churn to this bucket, are still extremely consistent quarter over quarter. So we're not seeing any big swings there at all.

Speaker 2

Great. Thanks so much.

Speaker 3

Yes, you're welcome.

Speaker 1

Your next question comes from the line of Jacob Stephens with Lake Street. Your line is open.

Speaker 4

Hey, guys. Congrats on the quarter. I guess the first question would kind of be focusing on the service Gross margins here. When I look at service gross margin declined sequentially, Is there anything specific you can really point to as the reasoning? And maybe just kind of reiterate Why do you think you could hit that 75% full year target?

Operator

Yes. Hey, Jacob, hey, glad to have you on the call. Yes. So as you pointed out, overall services gross margin quarter over quarter did drop slightly. We were at 75% on a non GAAP basis last quarter.

Operator

We were at 74%, 74.1% this quarter. A lot of that was driven by services revenue mix in the quarter. And as we've talked about in the past, we do have quarters where NRE is a bigger portion of our overall revenue. And our NRE service revenue tends to be at a lower margin profile. So that will happen quarter to quarter.

Operator

You may see some fluctuations. But I will say and I emphasize that we're still very extremely excited about how we're executing on the services business. As we mentioned previous quarter, we reiterate again this quarter that we expect that services business to be up 45% year over year, and we still are targeting for a full year to be in that range of 75%. So that's our target for the year.

Speaker 4

Okay. And so if I recall correctly, the guidance For service revenue growth year over year, it was raised slightly last quarter. And I think it equated to something around 48%. So is this kind of just a resetting of expectations or I guess just a little slight downtick or?

Operator

No, no. With the last quarter, yes, we definitely guided to in that $200,000,000 range for sure. I don't know if we actually cited the actual percentage growth. But what we see from when you look at last year's full year service revenue versus this year's full year service revenue, we, to be exact, will be up probably 45%. That's what we're targeting.

Speaker 4

Okay. And just one more on the kind of overall competitive environment. I mean ADT reported recently, they're kind of refocusing on the core business, launching some newer kind of lower ASP products. Do you see any new kind of competitors or any new competition from ADT or any of the other guys in the market today?

Speaker 3

Yes. It's a great question. We are actually seeing some more consolidation and actually some brands come out of our major channels, which I think provides some opportunity on the upside. So If I step back and just provide a little bit of commentary on what we're seeing across both arlo.com, but more specifically our retail and direct paid channels like the big retailers. We positioned ourselves, I think, extraordinarily well based on our pricing strategy and some of the things we talked about in our prepared remarks.

Speaker 3

We're expecting a great holiday season. I mentioned in the prepared remarks that we had an above forecast Our strong Amazon Big Deal Day, which was in the October timeframe. I'm happy to report today too that Walmart launched its AE event, which is its annual event, which is kind of its biggest promotion in Q4 for its holiday period yesterday. Arlo is the flagship product for that in this market segment. And we've got about a day and a half of data under our belt and it's actually stronger than expectation as well.

Speaker 3

So we're seeing, like I mentioned before, consistent resilient demand based on how we're In the channels and we're starting to see in certain channels, some of our competitors actually be pulled off the shelf as the retailers are concentrating on those brands that are actually investing in the channel and actually driving growth for them. So yes, there's some noise about certain products being here and there. But I would say the overall trends we're seeing in our channels are actually around us gaining share, us gaining mind share with the channel partners and seeing some of our competitors actually come off the shelf.

Speaker 4

Okay. Yes. That's very helpful. Thanks for all the color. Good luck going forward here guys.

Operator

Thank you. Your

Speaker 1

next Question comes from the line of Adam Tindle with Raymond James. Your line is open.

Speaker 5

Okay, thanks. Good afternoon. And congrats on the $200,000,000 of ARR, really nice milestone to hit there. I wanted to start, Matt, on net new I think it was just under 200,000, 197,000 for the quarter. And if we compare that to net new registered users, it looks like The attach rate that we could see is a little bit lower than it's been in a couple of quarters.

Speaker 5

And I wonder if there's maybe some rationale behind that. And then secondly, that 197 number is also a little bit lower sequentially. I think it's above your typical targets, but and you had some one timers in there. Just the what looks like the implied deceleration sequentially. Any comments on that and the implied attach rate on why it might look a little bit like a deceleration quarter over quarter?

Speaker 3

Yes, yes, exactly. Yes, yes, great question, Adam. And actually, The two questions you have are actually related. So I'll remind you in the previous, I guess, two quarters, We commented that Gersher, one of our top partners, is actually doing a bit of a catch up on the paid account numbers, right? Now from a revenue and all perspective, we're charging them correctly, but they had a firmware issue in one of their regions where it wasn't incrementing the actual paid account level.

Speaker 3

So if last quarter, which was closer to 240,000 and change from a net If you backed out that, it was right in the $170,000,000 to $190,000,000 range per quarter. So call it the $180,000,000 $185,000,000 roughly if you back that out. This quarter, same thing. They added fewer of a catch up. So we are closer to 200,000, the catch up was probably closer to 10000 to 15000, again, putting us right in that 170 to 190 range.

Speaker 3

So removing that noise from just the catch up, Actually, you're seeing consistent growth in paid subscribers as we're going forward. I will say that I think we'll see this continue. So they are not done cleaning up and doing firmware upgrades in that region to get the number to kind of increment correctly. And it's just an aberration on that single number. But it does affect certain calculations if you're dividing paid accounts for ARPU and some of those things.

Speaker 3

So it can shift things around a little bit. In reality, we're going to see, I think, still stick with that 170 to 190 range as we go forward. You may see a bigger catch up number next quarter, Maybe it's smaller. I think we probably have about 2 to maybe 3 more quarters of catch up at most before we can get back to just kind of the normal run rate of business. But again, if you back out that kind of fluctuating catch up from that one region in Europe, the paid account growth is actually perfectly consistent quarter over quarter and exactly within the range we've been talking about.

Speaker 5

Super helpful. Super helpful. Okay, thank you. And then just as a follow-up, the PRO monitoring release, obviously excited to see that. It's been a long time coming.

Speaker 5

Just curious if you could comment on, you Had a long time to think about this, how you're looking to differentiate with that platform. There's a number of these offerings out there, how you differentiate. And then Curt, if you could talk about the financial impact. I know it's probably fairly small right now. But if that grows to a bigger part of the business, what would it do to the financial profile?

Speaker 5

Thanks.

Speaker 3

Yes. So the total subscription, what we call total security subscriptions is a relatively unique offer, especially in the DIY space, right? We are basically underneath financing the hardware and the service together over 36 months, but it's being presented to the end user as a subscription because we'll roll them into a subscription on the 37th month. So it is seen as from an offering perspective as a single low monthly payment, no upfront cost and you're getting both the hardware and the professional monitoring for that. If you click through the website, you'll see there's actually 3 tiers, which is also interesting.

Speaker 3

So we have a starter pack that starts as low as $9.99 per month with professional monitoring. And then it goes all the way up to a more Advanced Pack that actually includes the full system plus cameras, multiple sensors and everything else. So it's got a wide offering range and it's starting at a very aggressive price point. And the offer, at least in the DIY space, is very unique. One of the reasons we're excited about it is it presents the solution very much in a similar fashion and a very competitive fashion against some of the more traditional security vendors that are out there.

Speaker 3

And there's roughly 20,000,000 to 25,000,000 households that have old traditional security at much higher monthly payments. And here's a solution that says we can not only lower your monthly payment, but there's no outlay for hardware. So the transition over is actually very easy for the end So that's the thought behind it. And it's great. We've already got people signing up, which is great even though we just launched a couple of hours ago.

Speaker 3

And so we're excited by that. We'll see how it goes, and then we're hoping to lean in even further next year into that type of offering in the market.

Operator

Yes. And then Adam, in terms of the overall operating model and the financial profile, it's actually very attractive for us. I mean, Matt, I think, talked about it last quarter that we're offering 20 fourseven monitoring type service, but it gives us the ability in our overall portfolio of service plans to uplift our subscribers into a higher plan. And typically, that higher plan is almost 60% greater than our overall blended average. So we see it as an operating model that is very healthy that allows us to expand ARPU and expand ARPU over time.

Operator

The great thing is, is right now, the total security solution we're providing is through our direct to consumer channel. And therefore, our profitability is much higher. Now we might experiment in getting into other channels with a similar type offering. But right now, it's a very healthy profitable channel for us, and we look to allow that to help us drive ARPU expansion over time while we're selling it through our direct to consumer channel.

Speaker 5

Okay, perfect. Just a quick clarification, Kurt. I just hear a lot of the financing component behind this. Could you just double click on how you went about looking to protect Arlo? Is there recourse to you for?

Operator

Great question, great question. And the answer is no. That's what was so important about building this partnership with the firm. When we started working on this several months ago, wanted to make sure that first the model would resonate with consumers and be over a nice 36 month period. But the great thing about this type of arrangement is we, Arlo, get paid upfront for the total package and then they service and take the risk associated with the credit over that 36 months.

Operator

So in our case, we have very little to no recourse around credit liability, and we get cash upfront, so it improves our overall free cash flow. What we want to focus on though is as we get to the 36 month term is what can we do to not only extend that contract with the customer, but also potentially get more services, more hardware bundled for the next phase of that relationship. So all good in terms of balance sheet and credit risk standpoint.

Speaker 5

Sounds great. Thank you, guys.

Speaker 3

Sure. Thank you, Av.

Speaker 1

Your next question comes from the line of Hamed Khorsand with BWS Financial.

Speaker 6

Could you elaborate on your holiday sales plans? Are you specifically about inventory? Are you over expressing on the essential side where it's going to be low price point items or is it a balanced mix?

Operator

Yes. So the

Speaker 3

it'll lean into definitely the new product launch, which is our new Essential 2 product. And I think that's a match of what we see just happening in the macroeconomic environment. So we're meeting the consumer where they are. From a unit perspective, it will be probably our largest quarter as a company from a holiday perspective. So we're excited by it.

Speaker 3

The plan is multichannel. I already mentioned the activity we had at Amazon earlier in the quarter. The Walmart deal is live as of yesterday. And you'll see some more unfold obviously through November and the beginning of December. It's probably the most robust holiday plan we've ever had.

Speaker 3

And it will be leaning as it usually does, leans into the most recent or the newest product at launch, which this year is essential to.

Operator

And then from an inventory perspective, I mean as we head into Q4, right now as we communicated, we're sitting in the $53,000,000 to $54,000,000 range, which frankly is a very comfortable level for us. Now we will be stocking up a bit in the early part of Q4 with the ability to replenish over time as these promotional campaigns execute with our retailers. I think we're well situated on our side from an inventory level, and we feel like the retail channel themselves, those retailers are in good standing as well. So I don't expect any concerns of meeting the demand. The demand seems to be evident and present.

Operator

We'll have sufficient supply, and we'll monitor it throughout the Q4 and make sure that we set ourselves up for success heading into Q1 of next year.

Speaker 6

And when looking into Q1 of next year with the 50% conversion rate, How much of a significant move do you expect in the retail ARPU?

Speaker 3

The retail hardware or retail service?

Speaker 6

The service ARPU, right, because you're giving away 90 days.

Speaker 3

Yes. Actually, our new yes, so our new trial is actually 30 days. So it some where it used to be relatively easy to take the entire volume shipped volume or POS volume in Q4 and say that will be service revenue in Q1 because of the 90 day free trial. As we've migrated to a 30 day trial, It's a little blurrier. So some of the sales hardware sales in Q4 might see some increased account activity in Q4.

Speaker 3

Some will actually be in Q4 and spillover into Q1. Holiday quarter Q4 always brings in some other timing variances. A lot of people buy products. And even if they buy in October, they stick it under the tree and don't open it until the end of December or potentially early Q1. And so there's some shifting there.

Speaker 3

So from an ARPU perspective, we're not expecting big shifts in ARPU. What I would say we're looking forward to is service revenue lift from potentially having more new households formed over a robust holiday period. And that's but that's some of the normal seasonality I think we've always had in our business. It's just it's a little blurrier as we move to a shorter free trial period.

Speaker 6

Great. Thank you.

Speaker 3

You're welcome.

Speaker 1

There are no further questions at this time. This does conclude today's conference call. Thank you for joining. You may now disconnect.

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Weyco Group Q3 2023
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