Arlo Technologies Q1 2023 Earnings Call Transcript

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May 11, 2023

There are 7 speakers on the call.

Operator

You, operator. Good afternoon, and welcome to Arlo Technologies' Q1 2023 Financial Results Conference Call. Joining us from the company are Mr. Matthew McRae, CEO and Mr. Kurt Bender, CFO.

Operator

The format of the call will start with an introduction and commentary on the business provided by Matt, followed by a review of the financials for the Q1, along with guidance for the Q2 and full year provided by Curt. We'll then have time for any questions. If you have not received a copy of today's release, please visit Arlo's Investor Relations website at investor. Arlo.com. Before we begin the formal remarks, we advise you that today's conference call contains forward looking statements.

Operator

Forward looking statements include statements regarding our potential future business, operating results and financial condition, including descriptions of our revenue, gross margins, operating margins, earnings per share, expenses, cash outlook, free cash flow and free cash flow margin, guidance for the Q2 and full year of 2023, the rate and timing of subscriber growth, the transition to a services first business model, the commercial launch and momentum of new products and services, strategic objectives and initiatives, market expansion and future growth, The effect of our brand awareness campaign on future growth, partnerships with various market leaders and strategic collaborators, continued new product and service differentiation and the impact of general macroeconomic conditions on our business, operating results and financial condition. Actual results or trends could differ materially from those contemplated by these forward looking statements. For more information, please refer to the risk factors discussed in Arlo's periodic filings with the SEC, including the most recent Annual Report on Form 10 ks and Quarterly Report on Form 10 Q. Any forward looking statements that we make on this call are based on assumptions as of today, and Arlo undertakes no obligation to update these statements as a result of new information or future events.

Operator

In addition, several non GAAP financial will be discussed on this call. A reconciliation of the GAAP to non GAAP measures can be found in today's press release on our Investor Relations website. At this time, I would now like to turn the call over to Matt.

Speaker 1

Thank you, Eric, and thank you everyone for joining us Today on Arlo's Q1 2023 earnings call. As I mentioned on our last call, Arlo had crossed an inflection point And our results in Q1 provide a glimpse of the bright future ahead. And while we remain cautious with regards to the overall macroeconomic outlook, The decisive operational actions we took at the end of Q3 combined with our recent product launches and new pricing strategy drove outstanding results and has positioned Arlo to outperform the market. We reached non GAAP Profitability ahead of expectation in Q1, we are guiding to a substantial increase in non GAAP profitability for Q2. We are raising full year guidance for 2023 and we expect our profitability and cash position to improve throughout the rest of the year.

Speaker 1

This underlines the continuing valuation dislocation for Arlo. We are redoubling our efforts to generate awareness with investors as we execute the business and strategy that is creating our successful trajectory. Looking at Q1 in more detail, Revenue came in at $111,000,000 which was above the high end of our guidance and we saw strong demand throughout the quarter, thereby driving our inventory lower. Arlo added 182,000 paid accounts and crossed the 2,000,000 paid account subscriber milestone in Q1. Earlier this year, we adjusted the pricing on our hardware and subscriptions To optimize our ability to drive shareholder value, lowering hardware prices to sell more units while increasing subscription pricing to accelerate service revenue.

Speaker 1

The price increases have had an immaterial impact on churn to date and we have seen an upward mix shift across our subscription plans. These factors drove service revenue up 47% year over year to $44,000,000 for the quarter and non GAAP service gross margin grew 380 basis points sequentially to reach a record 74%. Exiting the quarter, Arlo's annual recurring revenue grew an credible 80% year over year and reached $183,000,000 The observed price inelasticity And successful upselling is a testament to the value proposition Arlo services bring to our users as well as to the lifetime value of each subscriber. Arlo remains on track to continue our strong pace of subscriber additions and achieve $200,000,000 of Service revenue in 2023 at close to 75% non GAAP gross margin and growing nearly 50% year over year. The performance of our services business not only delivered non GAAP profitability, it drove $9,000,000 Free cash flow in Q1 and we expect Arlo to generate free cash flow and non GAAP profitability throughout the year leading to our target of 5% non GAAP operating margin for full year 2023.

Speaker 1

Underpinning this achievement is what continues to be heralded by many reviewers as the best cameras and doorbells available on the market. Our innovative, Technologically advanced portfolio of products propelled Arlo to the top of numerous best of 2023 lists in the quarter and awards from publications including The Verge, Consumer Reports, Engadget, Wirecutter, Android Police, Digital Camera World, New York Post, In The Know, Pocketnow, Flash Gear, Good Design, Digital Trends, Popular Mechanics and Tech Junky. We have also expanded our product portfolio to include a full security system with an advanced multi sensor at its core that provides numerous advantages over the competition. Arlo's extensive award winning product ecosystem It's a powerful subscriber acquisition lever that continues to drive new paid accounts. And Arlo Safe, our new personal and Family Safety Service opens new doors for users to enter our ecosystem.

Speaker 1

A simple download from the Apple or Google App Store begins a user's engagement with Arlo. I am pleased to share that today we announced a partnership with PingID, A company known for world class authentication and corporate security solutions, PingID will be providing Arlo Safe as an employee benefit across their company. This reflects an exciting new channel for Arlo to drive paid accounts. All of these services run on Arlo's smart cloud platform that provides an unparalleled level of security and performance for our That provides an unparalleled level of security and performance for our users and partners. The smart cloud architecture is flexible And scalable allowing us to quickly bring new features, services and solutions to market as we look to expand our capabilities and offerings over the next 24 months of our long range plan.

Speaker 1

And with that, I'll turn it over to Kurt.

Speaker 2

Thank you, Matt, and thank you everyone for joining us today. I will start by sharing some financial details and an overview of the business for Q1 2023. Revenue for the Q1 came in above the high end of our guidance at $111,000,000 down 6% sequentially and 11% year over year. The decline in revenue was attributed to lower product revenue, a trend which commenced in the second half of twenty twenty two in the face of a softening consumer demand environment. This trend was partially offset by our approach to reducing product prices as a catalyst to household acquisition and subscriber growth.

Speaker 2

To date, this approach has been effective and has enabled us to maintain strong subscriber additions and deliver strong growth of our highly profitable service revenue. We are extremely pleased with our services revenue and ARR growth, which helped deliver revenue above our guidance range and strongly contributed to Arlo delivering non GAAP net operating profit in Q1. Our service revenue for Q1 was another record at 44 $18,000,000 or 47 percent year over year and an increase of $5,600,000 or 15% quarter over quarter. The increase driven by the addition of 182,000 paid accounts in the quarter, coupled with certain in app enhanced functionality and features, enabled us to increase our subscription plan prices in the quarter. Additionally, our installed base reached a major milestone of 2,000,000 paid account subscribers during Q1, which represents an inflection point in our operating model.

Speaker 2

Service revenue accounted for 40% of our q1 2023 revenue and importantly represented 91% of our total gross profit. Additionally, Our quarter end ARR was $183,000,000 up 80% year over year and thereby providing greater predictability and visibility into our ability to deliver on near term revenue and profitability targets. Product revenue for Q1 was $67,000,000 down 16% sequentially and 29% year over year. During the quarter, we shipped a total 964,000 cameras worldwide with 50% of our revenue coming from our international Customers, in fact, we again experienced consistent results in the quarter with our strategic partner, VeriShore and EMEA, with product revenue up 27% sequentially, but slightly down 8% year over year. Our strong and collaborative relationship with VeriShore continues to be a very important one for us and a great intangible as we explore future growth From this point on, my discussion points will focus on non GAAP numbers.

Speaker 2

The reconciliation from GAAP to non GAAP figures is detailed in our earnings release distributed earlier today. Our non GAAP gross profit in the Q1 was $36,000,000 up 5% year over year. This resulted in a non GAAP gross margin of 33%, up 500 basis points from 28% in Q4 of 2022. The year over year increase And non GAAP gross profit in Q1 was attributable to growth in our service business as we had brought down Product gross margins as part of our overall pricing strategy. The improvement in non GAAP service gross profit was driven by growth in our ARR or subscription plan pricing and the monetization of our installed base of paid subscribers coupled with cost optimization.

Speaker 2

Non gas service gross margin for the quarter was 74%, significantly up from 70% in Q4 of 2022 65% in Q1 of 2022. Non GAAP product gross margin for the quarter was 6% and consistent with our guidance provided in March of this year. Total non GAAP operating expenses for the Q1 were $35,000,000 down sequentially and up $2,000,000 or 5% year over year. The year over year increase is attributable to continued investment in sales and marketing expenses to help drive household acquisition and subscriber growth. The non GAAP operating expenses for the Q1 were slightly better than our expectations and reflect the cost savings initiatives implemented in Q4.

Speaker 2

Our headcount at the end of Q1 was 334 employees, which represents a decrease from 343 team members at the end of Q4 and 358 team members in the same period last year. In Q1, We posted non GAAP net income of $1,100,000 Our non GAAP net income translates to earnings per diluted share of $0.01 much better than our guidance provided last quarter. The significant improvement in non GAAP Operating margin was driven by a combination of service revenue growth and gross margin expansion coupled with a disciplined approach to cost management. You can expect us to be deliberate and disciplined in managing operating expenses in line with revenue growth and our customer centric operating model. In Q4, we executed on various initiatives to reduce operating expenses, all of which have proven to be prudent considering the uncertain economic climate, but more so in aligning our organizational structure with the Services First strategy.

Speaker 2

Regarding our balance sheet and liquidity position, we ended the quarter with $118,700,000 in available cash, cash equivalents and short term investments. This balance was up nearly $5,000,000 sequentially and is well above the high end of our guidance range provided last quarter. We are pleased to report that we generated approximately 9 point $4,000,000 in free cash flow in Q1, which represents free cash flow margin of 8.5%, driven by our increased profitability and working capital management. Additionally, our Q1 inventory balance ended at $39,900,000 representing a decrease of $6,600,000 or 14% from Q4 of 2022 with inventory turns at 6.4x and consistent with last quarter. And finally, Our accounts receivable balance was $52,800,000 as of April 2, with Q1 DSOs At 44 days, down from 50 days sequentially and 58 days from the same period last year, We will continue to monitor our working capital balances in line with our revenue levels with a focus on maintaining a solid balance sheet and liquidity position in the future.

Speaker 2

Now turning to our outlook. Considering that Arlo surpassed the 2,000,000 paid account subscriber milestone this past quarter, Let me emphasize that the company is upon an inflection point in 2023. The forecasted revenue growth in our service business will drive Arlo to be materially profitable in 2023. Given the current consumer environment, We still remain cautious about our product revenue outlook for the year. With that said, we expect the 2nd quarter revenue for 2023 to be in the range of $105,000,000 to $115,000,000 We expect our GAAP net loss per diluted share to be between $0.15 $0.09 and our non GAAP net income per diluted share to be between $0.01 and $0.07 per share for Q2 of 2023.

Speaker 2

For the full year, we reiterate that service revenue is forecasted to grow at roughly 45% year over year to approximately $200,000,000 thereby becoming a much larger portion of our overall revenue and profitability mix. We estimate non GAAP product gross margin will be in the mid single digits as we pursue promotional activities and sales models that prioritize the acquisition of new households and subscribers. However, we Non GAAP service gross margin to be at or above 75% in 2023. Additionally, we are adjusting upwards our 2023 full year revenue range to be between 470 to $500,000,000 And now, I'll open it up for questions.

Speaker 3

Thank

Speaker 1

you.

Speaker 3

We'll go first to Jacob Stephen, Lake Street.

Speaker 4

Hey, guys. Congrats on the solid quarter. Certainly nice to see the free cash flow positive. Maybe just starting off, could we talk about kind of the 20% sequential monthly ARPU increase? I just want to see if you could Provide any more color, how we can kind of think about how much of the additional increase is related to the price, subscription increase and how we can kind of look at that moving forward?

Speaker 2

Sure, Jacob. Great to talk to you today. Just a couple of thoughts about the ARPU expansion. So obviously, you know that ARPU expansion is driven by a whole host of factors. Obviously, the increase in subscribers has played a big part in that, the mix of those subscribers.

Speaker 2

And then more recently, the price increase that we put in place in the quarter, we were really pleased to see that, given the in app functionality that we've added over the last several quarters, we were able to enact about a 20% to 30% increase in the actual pricing within our subscription plan. With that, we saw very little impact on churn. And as a result, it read through to a growth in our overall services revenue and the profitability that we experienced in the quarter. So pretty excited about the results for Q1 and we'll expect that the profitability of the services revenue to be in that gross margin range of about 75% for the remainder of the year.

Speaker 4

Okay, got it. And have you guys kind of talked about how we can think about The percentage of paid subs who pay monthly versus annually, I know there's a slight price difference on those 2?

Speaker 1

Yes. So we haven't broken that out yet and that Change or the addition of the annual plan happened mid quarter, so it's a little bit early. It's something that we could probably provide later in the year as we see things settle out. A couple of comments on it though. 1, as we made the price increase, to on the monthly plans as we Talked about obviously that had an impact on the quarter even though it happened in mid quarter.

Speaker 1

So we expect the Q1 of the full impact of that Price increases to happen in Q2. What's interesting is on the annual plan, even though they're at the discounted price, which Equals the old price on the monthly plans, those are also more profitable for us because we only do one transaction From a billing, credit card and clearance perspective instead of 12 throughout the year. So both the annual plan And obviously, the new pricing on the monthly plans are both accretive to profitability for us. But we haven't broken that out yet And something we'll probably do later commentary as it settles out and we get a full quarter under our belt.

Speaker 4

Okay, got it. Maybe just talk about the PingID announcement. Is that bundled in terms of subscription revenue Are each is each person who's getting the safe button, are they paying $25 a month and it's reimbursed by the company or tell me how that kind of contract Yes.

Speaker 1

It's very exciting announcement And

Speaker 4

just in terms of pipeline.

Speaker 1

Yes. No, I'm glad you brought it up. It's exciting for us because it's a first of its kind, B2B deal for us. And what I mean by that is it's Actually being provided as an employee benefit. So PingID as a company is purchasing the subscriptions for their employees And delivering them to their employee base as an added benefit of being an employee of PingID.

Speaker 1

So all of the features including personal safety, Family safety, crash protection, everything that Arlo Safe provides, will be part of the benefits of working at PingID. And so it's exciting for us, number 1, because PingID Such a household name in the business community at least around safety and security and it's a huge, I think vote around Arlo Safe being something that provides tremendous value to an individual and their family, but it's also exciting for us because this is us Seeing a new opportunity, a new potential go to market, specifically for Arlo Safe, but potentially Arlo Secure as well over time and that is Some of our services being seen as an employee benefit, which obviously could have future growth on paid accounts. So It's being bought by the company and being distributed for free to the employee as a benefit of being an employee at PingID.

Speaker 4

Okay, great. Maybe just one last one here. So you guys reported you had $98,000,000 in backlog to Verisure. I believe that was a new metric at the time. You shipped north of $40,000,000 in product in Q1 here.

Speaker 4

So that should leave roughly 50,000,000 and shipments kind of remaining in that backlog obligation. How can we think about the Verisher contract moving forward? It Seems like you guys have been progressing certainly nicely on that contract and maybe what does that look like going forward?

Speaker 2

Yes. So I'll just reiterate some of the commentary we've provided in the past. The relationship With, VeriShore is a good one for us, one that's very healthy and collaborative. So we're excited about its potential. As we've indicated, we're in the, I would say the last third of a 5 year contract, whereby they had purchased commitments in the range of $500,000,000 And so what we've done in the past As we've given backlog insight into the upcoming year, and so that backlog actually gets adjusted periodically throughout the year as Demand fluctuates and as we service that demand through supply.

Speaker 2

So in terms of the exact number, I don't know that we actually posted that in our quarter, But I would say that we're proceeding well against that $500,000,000 commitment. And we expect that by the end of that 5 years, we'll have exceeded that target. But it remains to be seen ultimately what the backlog will be for this year. I don't have that information available to share with you right now.

Speaker 4

Okay, got it. No, that's helpful. Great quarter guys. Best of luck going forward here. Thank you.

Speaker 3

Up next, we'll hear from Adam Tindle, Raymond James.

Speaker 5

Okay. Thanks. Good afternoon. Matt, maybe want to start with you. We've heard kind of a variety of different results from consumer companies, whether it's The WiFi arena, the home speaker arena, and a lot of them have been disappointing.

Speaker 5

And there's been some citations of channel inventory issues, particularly in e commerce or even retail where they're willing to hold less inventory. I guess when you look around the consumer electronics space Relative to your results, what do you think are the things that are maybe insulating you from The trends that are being experienced by others or do you think this is something that may ultimately impact our low at some point just on a lag effect?

Speaker 1

Yes, great question, Adam. So a couple of things I would say. 1, I think we are operating in a market segment that is just more naturally resilient to some of the headwinds that you would see in a macroeconomic slowdown. And what I mean by that is being in the segment of safety and security Often is a lot stickier and the demand is more resilient because it's around being safe, keeping your family safe, keeping your assets like a home We're small business safe and it's not one of the first things that consumers cut back when they're spending. And when there's a need For a safety or security solution, there's a need for a safety and security solution at that time.

Speaker 1

So I think from a general market perspective and market segmentation perspective, Safety and security is an area that's going to be more resilient as we go through this macroeconomic chaos that we're having a little bit of as we go forward. 2, I would say, we identified the turnaround in the market, I think earlier than most. So in Q3, we took actions across Many areas including cutting costs, really working with our supply chain to bring down product costs, changing our pricing. So we're bringing down the upfront cost even though we're increasing the monthly cost. Consumers are much more sensitive to the Out of box experience and the cost of getting into a solution.

Speaker 1

So we I think our pricing strategy has changed in a way to react to the market as the market Was becoming a little softer. That has worked. So we said on the last call that we expect This year to behave a lot like Q4 did as far as how consumers are looking for deals, they're looking for a lower upfront cost. But Once they're into a solution and they're subscribed as a subscriber, it's a very, very sticky service. So those are the 2 I would say.

Speaker 1

I think we're in a unique Market segment compared to things that are a lot more discretionary. And then 2, I think we have done an excellent job at reading where the market is Going adjusting our strategy across our operations, our supply chain and our pricing to match where the consumer is. And we're seeing that resilience continue even outside of Q1 as we're starting to go into Q2. So, we're that's one of the reasons why you see us upping Not only our future profitability, but actually upping the full year guidance on revenue is that we expect this to Continue and our success to continue throughout the rest of the year.

Speaker 5

Yes, certainly very prescient moves, makes sense to me. I guess maybe as a follow-up, the Secure product is such an interesting potential growth driver moving forward. And I'm curious kind of what you're learning as you venture down that journey and in particular the potential Partnerships that it might ultimately open up or go to markets and I mentioned that because there's just been a number of moves, whether it's Insurance providers like State Farm investing heavily in ADT or technology companies like Google and ADT, right, that are interested in those that have this sort of technology. So sort of these outside partnerships that might end up being open up to you from the secure piece of the business. Just wondering if you could talk about early observations and the opportunities for those sorts of partnerships moving forward and any timeline or visibility into that would be helpful?

Speaker 5

Thanks.

Speaker 1

Yes, another great question. I'll tell you I'm very bullish on what we call strategic accounts or partnerships going forward. I think there's a Overall recognition about the market segment that we're in and we just discussed together, the value it provides an end user, The revenue it can provide on a recurring basis. There's only a certain number of segments that consumers will pay on a monthly or Recurring basis for value that's provided through a subscription. When you look at the smart home, it's really around security.

Speaker 1

So I think there's many avenues Of which you've touched on, whether it's service providers or insurance and other insurance companies or other B2B partners where Arlo is potentially a great fit as a partner. When we talked about our long range plan last year and last March when we rolled it out, one of our key pillars Was continuing to invest in and expanding our B2B strategic account base. It's a focus for us. We don't have anything to announce At the moment, but I will tell you, I do believe there's some very strong potential and I'm bullish over the call it the 12 to 18 month time horizon That it will continue to drive results for Arlo, continue to drive paid accounts and become an even a bigger portion of our business as

Speaker 4

we head forward.

Speaker 5

Great. Looking forward to it. Thanks and congrats.

Speaker 1

Thank you very much, John.

Speaker 3

Next up, we'll hear from Hamed Khorsand, BWS Financial.

Speaker 6

Hi. Could you first address the price changes you undertook in the quarter and How much of your subscriber base saw that price increase in Q1 and how much how many will see it in Q2?

Speaker 1

Yes. So the price changes happened over the course of February. And the reason it didn't happen on a single day is it depends on when the natural Renew date happens. So if you are on the 5th of a month, it renewed on the 5th February. If you are on the 14th of the month, it would be the 14th February.

Speaker 1

So throughout the month of February, 100% of our subscriber base rolled into the new pricing. So It basically happened throughout February. So on an average, you would say half the quarter was benefiting from that price increase. Of course, next quarter will be 100%. But as we exited February, meaning going into March, 100% of the subscriber base was moved over to the new pricing.

Speaker 6

Okay. And then in your pre made remarks, you had said something about mix shift in service plans. Are you seeing more Movement towards the higher end or the lower end of your service plans now with the higher price points?

Speaker 1

Yes, great question. So we are seeing an increase, Meaning an upward shift. So as I think the security system is starting to roll out as Arlo Safe has rolled out in a bundle, we have our Arlo Safe and Sure. Plus, we are seeing a mix up, where people are signing up for more higher priced plans compared to historical. So I think Kurt kind of alluded that in his answer to a question around both Price increases and the mix shift upwards in price selection or plan selection has impacted ARPU.

Speaker 6

Okay. My last question was just given the seasonality of the Q1, how do you feel about the point Sale transactions now with your focus being on price, do you feel like you're winning market share?

Speaker 1

Yes. I do think we're winning market share. It's been obviously a strong quarter. And as I mentioned, we're seeing that resilience in the consumer continue as we go forward. So we think we're absolutely on the right Strategy, we think it's going to drive not only some market share gain, but obviously paid accounts as we get through the year.

Speaker 1

So We're really happy with where we're sitting. We think the pricing strategy was exactly the right move, especially as we are a services business At the forefront and the hardware sale is really how we instantiate that relationship with the end user and this is really leaning into that and it's providing great results for the company.

Speaker 6

Okay. Thank you.

Speaker 1

Thank you, Amit.

Speaker 3

That does conclude the question and answer session and also concludes today's conference.

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