What changed in this filing

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Item 7. Management’s Discussion and Analysis

2021-02-26 compared with 2020-02-28 · 206 added, 168 removed, 369 unchanged (50% of the section changed)

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Business and Executive Overview

Arlo combines an intelligent cloud infrastructure and mobile app with a variety of smart connected devices that transform the way people experience the connected lifestyle.

Arlo combines an intelligent cloud infrastructure and mobile app with a variety of smart connected devices that is transforming the way people experience the connected lifestyle.

Arlo’s deep expertise in product design, wireless connectivity, cloud infrastructure and cutting-edge AI capabilities focuses on delivering a seamless, smart home experience for Arlo users that is easy to setup and interact with every day.

Our cloud-based platform provides users with visibility, insight and a powerful means to help protect and connect in real-time with the people and things that matter most, from any location with a Wi-Fi or a cellular connection.

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Europe, Middle-East and Africa (“EMEA”);

and Asia Pacific (“APAC”) and we primarily generate revenue by selling devices through retail, wholesale distribution and wireless carrier channels and paid subscription services through in-app purchases.

and Asia Pacific (“APAC”) and we primarily generate revenue by selling devices through retail, wholesale distribution, wireless carrier channels, security solution providers, Arlo's direct to consumer store and paid subscription services.

International revenue was 28.4%, 26.6% and 22.6% of our revenue for the years ended December 31, 2020, 2019 and 2018, respectively.

For the years ended December 31, 2020, 2019 and 2018, we generated revenue of $357.2 million, $370.0 million and $464.9 million, respectively.

Loss from operations was $85.2 million for the year ended December 31, 2019 compared with Loss from operations of $74.8 million for the year ended December 31, 2018 and Income from operations of $5.7 million for the year ended December 31, 2017 .

Income (loss) from operations for the year ended December 31, 2019 , 2018 and 2017 included separation expense of $1.9 million , $27.3 million , and $1.4 million , respectively.

Loss from operations was $104.9 million, $85.2 million, $74.8 million for the years ended December 31, 2020, 2019 and 2018, respectively.

Income (loss) from operations for the years ended December 31, 2020, 2019 and 2018 included separation expense of $0.2 million, $1.9 million and $27.3 million, respectively.

Income (loss) from operations for the years ended December 31, 2020 and 2019 included gain on sale of business of $0.3 million and $54.9 million, respectively.

Our goal is to continue to develop innovative, world-class connected lifestyle solutions to expand and further monetize our current and future user and subscriber bases.

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In addition to the measures presented in our consolidated financial statements, we use the following key metrics to evaluate our business, measure our performance, develop financial forecasts and make strategic decisions.

In addition, management’s incentive compensation is partially determined using certain of these key business metrics.

In 2019, management’s incentive compensation was partially determined using certain of these key business metrics.

We believe these key business metrics provide useful information by offering the ability to make more meaningful period-to-period comparisons of our on-going operating results and a better understanding of how management plans and measures our underlying business.

Our key business metrics may be calculated in a manner different from the same key business metrics used by other companies.

We regularly review our processes for calculating these metrics, and from time to time we may discover inaccuracies in our metrics or make adjustments to better reflect our business or to improve their accuracy, including adjustments that may result in the recalculation of our historical metrics.

including adjustments that may result in the recalculation of our historical metrics.

We believe that any such inaccuracies or adjustments are immaterial unless otherwise stated.

As of and for the Year Ended December 31, (1)

Year Ended As of and for the Year Ended December 31,

2020 % Change 2019 % Change 2018

(In thousands, except percentage data)

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Cumulative paid accounts 435 89.1 % 230 59.7 % 144

Devices shipped for the period

_________________________

(1) Starting with this Annual Report Form 10-K, Service Revenue is included as a line item in the consolidated statement of operations in Item 8 of Part II of this Annual Report on Form 10-K.

Cumulative Registered Accounts .

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The number of registered accounts does not necessarily reflect the number of end-users on the Arlo platform, as one registered account may be used by multiple people.

We have changed our definition from registered users to registered accounts due to the Verisure transaction, Verisure will own the registered accounts but we will continue to provide services to these European customers under the Verisure Agreements.

Paid Accounts.

We changed our definition from registered users to registered accounts starting in the fourth quarter of 2019 due to the Verisure transaction.

Verisure will own the registered accounts but we will continue to provide services to these European customers under the Verisure Agreements.

Cumulative Paid Accounts.

Paid accounts worldwide measured as any account where a subscription to a paid service is being collected (either by the Company or by the Company’s customers or channel partners), plus paid service plans of a duration of more than 3 months bundled with products (such bundles being counted as a paid account after 90 days have elapsed from the date of registration).

During the second quarter of 2019, we factored in an adjustment to the first quarter of 2019 paid account number and have subsequently revised the first quarter of 2019 paid accounts total to 162,000.

We have redefined paid subscribers as paid accounts to include customers that were transferred to Verisure as part of the disposal of our commercial operations in Europe because we will continue to provide services to these European customers and receive payments under the Verisure Agreements.

Devices Shipped .

Devices shipped represents the number of Arlo cameras, lights, and doorbells that are shipped to our customers during a period.

Devices shipped does not include shipments of Arlo accessories and Arlo base stations, nor does it take into account returns of Arlo cameras, lights, and doorbells.

The growth rate of our revenue is not necessarily correlated with our growth rate of devices shipped, as our revenue is affected by a number of other variables, including but not limited to returns from customers, end-user customer rebates and other channel sales incentives deemed to be a reduction of revenue per the authoritative guidance for revenue recognition, sales of accessories, and premium services, the types of Arlo products sold during the relevant period and the introduction of new product offerings that have different U.S.

manufacturer’s suggested retail prices.

In the fourth quarter of 2019, we redefined paid subscribers as paid accounts to include customers that were transferred to Verisure as part of the disposal of our commercial operations in Europe because we will continue to provide services to these European customers and receive payments associated with them, under the Verisure Agreements.

Impact of COVID-19

On March 11, 2020, the World Health Organization announced that COVID-19, a respiratory illness, caused by a novel coronavirus, is a pandemic.

COVID-19 has spread to many of the countries in which we, our customers, our suppliers and our other business partners conduct business.

Governments in affected regions have implemented, and may continue to implement, safety precautions which include quarantines, travel restrictions, business closures, cancellations of public gatherings and other measures as they deem necessary.

Many organizations and individuals, including the Company and its employees are taking additional steps to avoid or reduce infection, including limiting travel and staying home from work.

These measures are disrupting normal business operations both in and outside of affected areas and have had significant negative impacts on businesses and financial markets worldwide.

We anticipate that our financial results could be adversely impacted due to:

• temporary closure or decrease in foot traffic to our major customers' retail stores and shift of focus to essential goods distribution;

• disruption to our supply chain caused by delayed delivery of components from our third-party manufacturers and other suppliers located in regions affected by COVID-19;

• deferment of customer spending due to economic uncertainty;

• decreased productivity due to travel bans, work-from-home policies or shelter in place orders;

• a slow-down in the global economy or a credit crisis.

The onset of the COVID-19 pandemic started to affect our product shipments in the second quarter of 2020 due to our major customers' retail stores facing temporary closures and decreases in foot traffic, certain of our customers shifting focus to essential goods distribution, and other uncertainties caused by the pandemic.

The decline in product shipments continued throughout the fourth quarter of 2020.

As of December 31, 2020, Americas retail channel inventory

declined compared to December 31, 2019 due to lower inventory holding by our Retail Channel customers during the pandemic.

This has contributed to a 6.8% decline in net revenue in the Americas, compared to the prior year.

In addition, international freight capacity has dropped, causing air and ocean freight rates to materially increase.

Furthermore, transit times have also increased.

For the year ended December 31, 2020, we saw a 56% increase in freight-in expense compared to the prior year, as a result of the higher sea and airfreight rates.

While this is expected to be temporary, the current circumstances are dynamic and the future impacts of COVID-19 on our business operations, including their duration and impact on overall customer demand, cannot be reasonably estimated at this time.

Our priorities and actions during the COVID-19 pandemic are focused on protecting the health and safety of all those we serve, our employees, our customers, our suppliers and our communities, including implementing early and continuous updates to our health and safety policies and processes.

We have successfully migrated all but a limited number of our global workforce to work remotely while local and state governments have imposed shelter-in-place orders in the United States and around the world.

We are focused on providing our team with the resources that they need to meet the needs of our customers and deliver new innovations to the markets we serve, despite challenges introduced by the COVID-19 pandemic.

We continue to work with our suppliers to address any supply chain disruptions, which might include larger component backlogs, travel restrictions and logistics changes that can impact our operations.

For example, increased demand for electronics as a result of the COVID-19 pandemic, effects of the U.S.

trade war with China, increased demand for chips in the automotive industry and certain other factors have led to a global shortage of semiconductors.

Due to such shortage, starting in the fourth quarter of 2020 we started to experience component shortages, including longer lead times for components, and supply constraints, which we expect to continue into 2021.

Such shortages and constraints are affecting our ability to meet scheduled product deliveries and worldwide demand for our products in the first quarter of 2021 and potentially beyond.

As a result, we could experience material charges from potential adjustments of the carrying value of our inventories and trade receivables, impairment charges on our long-lived assets, intangible assets and goodwill, and changes in the effectiveness of the Company’s hedging instruments, among others.

We also anticipate that COVID-19 could continue to reduce our revenues and increase product and service costs and operating expenses for fiscal year 2021.

We are focused on navigating these recent challenges presented by COVID-19 through preserving our liquidity and managing our cash flow through taking preemptive action to enhance our ability to meet our short-term liquidity needs.

These actions include, but are not limited to, proactively managing working capital by closely monitoring customers' credit and collections, renegotiating payment terms with third-party manufacturers and key suppliers, closely monitoring inventory levels and purchases against forecasted demand, reducing or eliminating non-essential spending, and deferment of hiring.

We continue to monitor this rapidly developing situation and may, as necessary, reduce expenditures further, borrow under our revolving credit facility, or pursue other sources of capital that may include other forms of external financing in order to maintain our cash position and preserve financial flexibility in response to the uncertainty in the United States and global markets resulting from the COVID-19 pandemic.

Comparability of Historical Results

The operating results of Arlo have historically been disclosed as a reportable segment within the consolidated financial statements of NETGEAR, enabling the identification of directly attributable transactional information, functional departments, and headcount.

Through July 1, 2018, Revenue and Cost of revenue, with the exception of channel sales incentives, were derived from transactional information specific to Arlo products and services.

Through July 1, 2018, the operating results of Arlo had historically been disclosed as a reportable segment within the consolidated financial statements of NETGEAR, enabling the identification of directly attributable transactional information, functional departments, and headcount.

Revenue and Cost of revenue, with the exception of channel sales incentives, were derived from transactional information specific to Arlo products and services.

Directly attributable operating expenses were derived from activities relating to Arlo functional departments and headcount.

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Stock-based compensation expense has been either directly reported by or allocated to Arlo based on the awards and terms previously granted to NETGEAR’s employees.

The consolidated statements of operations of the Company as presented reflect the directly attributable transactional information specific to Arlo and certain additional allocated costs through July 1, 2018.

The allocated costs for corporate functions included, but were not limited to, allocations of general corporate expenses from NETGEAR including expenses related to corporate services, such as executive management, information technology, legal, finance and accounting,

human resources, tax, treasury, research and development, sales and marketing, shared facilities and other shared services.

The consolidated statements of operations of the Company as presented for the year ended 2018 reflect the directly attributable transactional information specific to Arlo and certain additional allocated costs through July 1, 2018.

The allocated costs for corporate functions included, but were not limited to, allocations of general corporate expenses

from NETGEAR including expenses related to corporate services, such as executive management, information technology, legal, finance and accounting, human resources, tax, treasury, research and development, sales and marketing, shared facilities and other shared services.

These costs were allocated based on revenue, headcount, or other measures the Company has determined as reasonable.

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The amount of these allocations from NETGEAR reflected within operating expenses in the consolidated statements of operations was $30.6 million from January 1, 2018 to the date of the completion of the IPO, which included $9.4 million for research and development, $10.0 million for sales and marketing, and $11.2 million for general and administrative expense.

For the year ended December 31, 2017, allocations amounted to $40.0 million, which included $11.8 million for research and development, $13.1 million for sales and marketing and $15.1 million for general and administrative expense.

The management of Arlo believes the assumptions underlying the consolidated financial statements, including the assumptions regarding the allocated expenses, reasonably reflect the utilization of services provided, or the benefit received by Arlo during the periods presented.

Nevertheless, the consolidated financial statements may not be indicative of Arlo’s future performance and do not necessarily reflect Arlo’s results of operations, financial position, and cash flows had Arlo been a standalone company during the periods presented.

Our Relationship with NETGEAR

On August 2, 2018, in connection with the IPO, the Company entered into a master separation agreement, a transition services agreement, an intellectual property rights cross-license agreement, a tax matters agreement, an employee matters agreement, and a registration rights agreement, in each case with NETGEAR, which effect the Separation, provide a framework for the Company’s relationship with NETGEAR after the Separation and provide for the allocation between NETGEAR and the Company of NETGEAR’s assets, employees, liabilities and obligations (including its investments, property and employee benefits assets and liabilities) attributable to periods prior to, at and after the Separation.

NETGEAR has provided certain of the services on a transitional basis following the Distribution pursuant to the Transition Services Agreement ("NETGEAR TSA").

Under the NETGEAR TSA, NETGEAR charges a fee that is consistent with our historical allocation for such services.

During the year ended December 31, 2018 , we incurred $6.3 million in NETGEAR TSA related costs, which included $0.4 million for research and development, $1.6 million for sales and marketing, and $4.3 million for general and administrative expense.

During the year ended December 31, 2019 , we incurred $0.7 million in NETGEAR TSA related costs, which included $0.1 million for cost of revenue, $0.3 million for research and development, $0.1 million for sales and marketing, and $0.2 million for general and administrative expense.

We do not expect to incur any NETGEAR TSA related costs during fiscal year 2020.

In addition, to operate as a standalone company, we incurred costs to replace certain services that were previously provided by NETGEAR, which were higher than those reflected in our historical combined financial statements.

The most significant component of these costs was IT-related costs, including capital expenditures, to implement certain new systems, including infrastructure and an enterprise resource planning system.

As of December 31, 2018, we have fully completed the implementation of these new systems.

We are subject to the reporting requirements of the Exchange Act, and we are required to establish procedures and practices as a standalone public company in order to comply with our obligations under the Exchange Act and related rules and regulations, as well as rules of the New York Stock Exchange.

As a result, we will continue to incur additional costs, including internal audit, investor relations, stock administration, and regulatory compliance costs.

These additional costs may differ from the costs that were historically allocated to us by NETGEAR.

Components of Our Operating Results

Our gross revenue consists primarily of sales of devices and prepaid and paid subscription service revenue.

Our gross revenue consists primarily of sales of devices, prepaid and paid subscription service revenue and NRE service revenue from Verisure.

We generally recognize revenue from product sales at the time the product is shipped and transfer of control from us to the customer occurs.

Our prepaid services primarily pertain to devices which are sold with our Arlo prepaid services offering, providing users with the ability to store and access data for up to five cameras for a rolling seven-day period, one-year free subscription for basic services.

Prepaid services also include one year of Arlo Smart bundled with our for our Arlo Ultra products launched in early 2019, and three-month free subscription for Arlo Smart services for our Arlo Pro 3 products launched in late September 2019 and Arlo Video Doorbell launched in late November 2019.

Our First generation camera products under our old business model come with a prepaid service that provides users with rolling seven-day cloud video storage, the ability to connect up to five cameras and 90 days of customer support.

Our second generation camera, doorbell and floodlight products under our new business model come with a prepaid service that includes a one-year free trial period of Arlo Smart bundled with our Arlo Ultra products launched in early 2019, and a three-month free trial period of Arlo Smart bundled with our products launched after September 2019.

Upon device shipment, we attribute a portion of the sales price to the prepaid service, deferring this revenue at the outset and subsequently recognizing it ratably over the estimated useful life of the device or free trial period, as applicable.

Our paid subscription services relate to sales of subscription plans to our registered accounts.

Our services also include certain development services provided to Verisure under a NRE arrangement as part of the disposal of our commercial operations in Europe in the fourth quarter of 2019.

Refer to Note 4, Disposal of Business, in the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K for a complete discussion of the NRE arrangement.

Our revenue consists of gross revenue, less end-user customer rebates and other channel sales incentives deemed to be a reduction of revenue per the authoritative guidance for revenue recognition, allowances for estimated sales returns, price protection, and net changes in deferred revenue.

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Under the Supply Agreement, Verisure became the exclusive distributor of our products in Europe for all channels, and will non-exclusively distribute our products through its direct channels globally.

Revenue associated with the NRE arrangement under the Supply Contract is not significant for the year ended December 31, 2019.

We expect that our revenue and profitability in Europe will improve over the life of the Supply Agreement.

We expect that our revenue and gross margin for the first half of 2020 will be negatively impacted by delayed delivery of components from suppliers located in regions affected by COVID-19 and other potential impacts of COVID-19 on our operations.

We expect that our revenue and profitability in Europe will improve over the lifetime of the Supply Agreement.

Refer to Note 4, Disposal of Business , in the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K for a complete discussion of the Supply Agreement.

Cost of Revenue

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the cost of finished products from our third-party manufacturers;

overhead costs, including purchasing, product planning, inventory control, warehousing and distribution logistics, third-party software licensing fees, inbound freight, warranty costs associated with returned goods, write-downs for excess and obsolete inventory, royalties to third parties;

overhead costs, including purchasing, product planning, inventory control, warehousing and distribution logistics, third-party software licensing fees, inbound freight, IT and facilities overhead, warranty costs associated with returned goods, write-downs for excess and obsolete inventory, royalties to third

and amortization expense of certain acquired intangibles.

Cost of service consists of costs attributable to the provision and maintenance of our cloud-based platform, including personnel, storage, security, and computing.

Cost of service consists of costs attributable to the provision and maintenance of our cloud-based platform, including personnel, storage, security and computing, as well as NRE service costs incurred under the Verisure NRE arrangement.

Our cost of revenue as a percentage of revenue can vary based upon a number of factors, including those that may affect our revenue set forth above and factors that may affect our cost of revenue, including, without limitation:

product mix, sales channel mix, registered user acceptance of paid subscription service offerings, fluctuation in foreign exchange rates and changes in our cost of goods sold due to fluctuations in prices paid for components, net of vendor rebates, cloud platform costs, warranty and overhead costs, inbound freight and duty product conversion costs, charges for excess or obsolete inventory, and amortization of acquired intangibles.

product mix, sales channel mix, registered accounts' acceptance of paid subscription service offerings, fluctuation in foreign exchange rates and changes in our cost of goods sold due to fluctuations in prices paid for components, net of vendor rebates, cloud platform costs, warranty and overhead costs, inbound freight and duty product conversion costs, charges for excess or obsolete inventory, and amortization of acquired intangibles.

We outsource our manufacturing, warehousing, and distribution logistics.

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Research and Development

Research and development expense consists primarily of personnel-related expense, safety, security, regulatory services and testing, other research and development consulting fees, and corporate IT and facilities overhead.

We recognize research and development expense as it is incurred.

We have invested in and expanded our research and development organization to enhance our ability to introduce innovative products and services.

We believe that innovation and technological leadership are critical to our future success, and we are committed to continuing a significant level of research and development to develop new technologies, products, and services, including our hardware devices, cloud-based software,

AI-based algorithms, and machine learning capabilities.

We expect research and development expense to stay relatively flat in absolute dollars as we manage our expenses while continuing to develop new product and service offerings to support the connected lifestyle market.

We expect research and development expense to fluctuate depending on the timing and number of development activities in any given period, and such expense could vary significantly as a percentage of revenue, depending on actual revenue achieved in any given period.

We expect research and development expense to stay relatively flat in absolute dollars for fiscal 2021 as we manage our expenses while continuing to develop new product and service offerings to support the connected lifestyle market.

Sales and Marketing

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IT and facilities overhead;

outbound freight costs;

and amortization of certain intangibles.

We expect our sales and marketing expense to fluctuate based on the seasonality of our business for the foreseeable future.

and outbound freight costs.

We expect our sales and marketing expense to fluctuate for the foreseeable future based on the seasonality of our business, the growth of our direct to consumer store, and the extent to which we invest in marketing to drive awareness of our brand and drive demand for our products.

General and Administrative

General and administrative expense consists primarily of personnel-related expense for certain executives, finance and accounting, investor relations, human resources, legal, information technology, professional fees, corporate IT and facilities overhead, strategic initiative expense, and other general corporate expense.

We expect our general and administrative expense to moderately decrease in absolute dollars.

General and administrative expense consists primarily of personnel-related expense for certain executives, finance and accounting, investor relations, human resources, legal, information technology, professional fees, IT and facilities overhead, strategic initiative expense, and other general corporate expense.

We expect our general and administrative expense to stay relatively flat in absolute dollars.

However, we also expect our general and administrative expense to fluctuate as a percentage of our revenue in future periods based on fluctuations in our revenue and the timing of such expense.

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Separation expense consists primarily of costs associated with our separation from NETGEAR, including third-party advisory, consulting, legal and professional services for separation matters including IPO-related litigation, IT-related expenses directly related to our separation from NETGEAR, and other items that are incremental and one-time in nature.

To operate as a standalone company, we have incurred separation costs of $27.3 million and $1.9 million during the years ended December 31, 2018 and 2019, respectively, to replicate certain services previously provided by NETGEAR.

The significant reduction during the year ended December 31, 2019 was as a result of the substantial completion of our Separation from NETGEAR on December 31, 2018.

To operate as a standalone company, we have incurred separation costs of $0.2 million, $1.9 million and $27.3 million during the years ended December 31, 2020, 2019 and 2018, respectively, to replicate certain services previously provided by NETGEAR.

The significant reduction during the years ended December 31, 2020 and 2019 was as a result of the substantial completion of our Separation from NETGEAR on December 31, 2018.

Gain on sale of business

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Interest income represents interest earned on our cash, cash equivalents and short-term investments.

We expect our interest income in absolute dollars to decrease as we use up our short-term investments and cash and cash equivalents to fund our operations, while interest rates have also declined.

Other Income (Expense), Net

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Under this method, we recognize income tax liabilities or receivable for the current year.

We also recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting

and tax basis of assets and liabilities, as well as for operating loss and tax credit carryforwards.

We also recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities, as well as for operating loss and tax credit carryforwards.

Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled.

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As we expand internationally, we will face increased complexity in determining the appropriate tax jurisdictions for revenue and expense items.

Our policy is to adjust these reserves when facts and circumstances change, such as the closing of a tax audit or refinement of an estimate.

Our policy is to adjust these unrecognized tax benefits in the period when facts and circumstances change, such as the closing of a tax audit, the expiration of statute of limitation for a relevant taxing authority to examine a tax position, or when additional information becomes available.

To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made and could have a material impact on our financial condition and operating results.

The provision for income taxes includes the effects of any accruals that we believe are appropriate, as well as the related net interest and penalties.

The Tax Cuts and Jobs Act of 2017 ("Tax Act") introduced the global intangible low-taxed income (“GILTI”) provisions effective in 2018, which generally impose a tax on the net income earned by foreign subsidiaries of U.S company in excess of a deemed return on their tangible assets.

The provision for income taxes includes the effects of any accruals that we believe are appropriate, as well as the related interest and penalties.

The Tax Cut and Jobs Act of 2017 ("Tax Act") introduced the global intangible low-taxed income (“GILTI”) provisions effective in 2018, which generally impose a tax on the net income earned by foreign subsidiaries of U.S company in excess of a deemed return on their tangible assets.

We recognize the tax on GILTI as a period cost when the tax is incurred.

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Year Ended December 31,

2020 2019 2018

(In thousands, except percentage data)

Products $ 284,868 79.8 % $ 323,242 87.4 % $ 427,113 91.9 %

Services 72,286 20.2 % 46,765 12.6 % 37,805 8.1 %

Total revenue 357,154 100.0 % 370,007 100.0 % 464,918 100.0 %

Cost of revenue:

Products 263,905 73.9 % 307,348 83.1 % 354,023 76.1 %

Services 37,860 10.6 % 26,855 7.3 % 18,820 4.0 %

Total cost of revenue 301,765 84.5 % 334,203 90.3 % 372,843 80.2 %

Gross profit 55,389 15.5 % 35,804 9.7 % 92,075 19.8 %

Operating expenses:

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Total operating expenses 160,253 44.9 % 121,025 32.7 % 166,848 35.9 %

Income (loss) from operations

Loss from operations (104,864) (29.4) % (85,221) (23.0) % (74,773) (16.1) %

Interest income 802 0.2 % 2,737 0.7 % 1,239 0.3 %

Other income (expense), net 3,436 1.1 % 913 0.2 % (1,177) (0.3) %

Income (loss) before income taxes

Loss before income taxes (100,626) (28.1) % (81,571) (22.0) % (74,711) (16.1) %

Provision for income taxes 625 0.2 % 4,380 1.2 % 772 0.1 %

Net income (loss)

Net loss $ (101,251) (28.3) % $ (85,951) (23.2) % $ (75,483) (16.2) %

We conduct business across three geographic regions:

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Year Ended December 31,

2020 % Change 2019 % Change 2018

(In thousands, except percentage data)

Americas $ 269,395 (6.8) % $ 289,160 (23.3) % $ 376,805

Percentage of revenue 75.4 % 78.1 % 81.0 %

EMEA $ 61,832 8.0 % $ 57,232 (12.6) % $ 65,462

Percentage of revenue 17.3 % 15.5 % 14.1 %

APAC $ 25,927 9.8 % $ 23,615 4.3 % $ 22,651

Percentage of revenue 7.3 % 6.4 % 4.9 %

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Revenue decreased 3.5% across all geographic regions for the year ended December 31, 2020 compared to the prior year.

The decrease was primarily driven by a slowdown in our customer demand for connected cameras, increased competition, higher marketing expenditures deemed to be a reduction of revenues, increased in provisions for price protection that are deemed to be a reduction of revenue, offset by higher service revenue.

The decrease was primarily driven by a decrease in product shipments as a result of disruption to our sales channels due to the COVID-19 pandemic and a slowdown in our customer demand for connected cameras, partially offset by an increase in service revenue and less provisions for sales returns, price protection and marketing expenditures that are deemed to be a reduction of revenue.

Service revenue increased by $25.5 million, or 54.6%, for the year ended December 31, 2020 compared to the prior year, due to increased paid accounts and recognition of NRE and other incremental service revenue from Verisure in the fiscal year 2020.

Revenue decreased 20.4% across all geographic regions for the year ended December 31, 2019 compared to the prior year.

The decrease was primarily driven by a slowdown in our customer demand for connected cameras, increased competition, higher marketing expenditures deemed to be a reduction of revenues, increased provisions for price protection that are deemed to be a reduction of revenue, offset by higher service revenue.

We launched Arlo Ultra, with 4K video resolution capability, in the first fiscal quarter of 2019, Arlo Pro 3, with 2K video resolution capability, in the third fiscal quarter of 2019 and Arlo Video Doorbell with 180 degree viewing angle, in the fourth quarter of 2019.

Service revenue increased by $9.0 million, or 23.7%, for the year ended December 31, 2019 compared to the prior year, as our paid subscribers increased compared to the prior year.

Revenue increased 25.4% across all geographic regions for the year ended December 31, 2018 compared to the prior year.

The increase was primarily driven by continued rollout of our Arlo Pro 2 camera, which launched in the fourth quarter of fiscal 2017.

Additionally, service revenue increased by $8.7 million, or 30.0%, for the year ended December 31, 2018 compared to the prior year.

We experienced a slowdown in end user demand for our cameras in the fourth quarter of 2018.

Cost of Revenue and Gross Margin

The following table presents cost of revenue and gross margin for the periods indicated:

Cost of Revenue

The following table presents cost of revenue for the periods indicated:

Year Ended December 31,

2020 % Change 2019 % Change 2018

(In thousands, except percentage data)

Cost of revenue:

Products $ 263,905 (14.1) % $ 307,348 (13.2) % $ 354,023

Services 37,860 41.0 % 26,855 42.7 % 18,820

Total cost of revenue $ 301,765 (9.7) % $ 334,203 (10.4) % $ 372,843

Cost of revenue decreased for the year ended December 31, 2019 , due primarily to a decline in product revenue compared to the prior year.

Service cost of revenue increased for the year ended December 31, 2019 , in line with the service revenue growth and due to our continued investment in our cloud service offerings to improve our customer experience and to enhance our security profile.

Gross margin decreased significantly for the year ended December 31, 2019 compared to the prior year, due to a combination of both product and service margin declines.

The product margin decline is primarily due to increased marketing expenditures deemed to be a reduction of revenues, increased provisions for price

protection that are deemed to be reductions of revenue, increased warranty costs, product overhead and freight-related costs, offset by less charges for excess or obsolete inventory.

Cost of products revenue decreased for the year ended December 31, 2020, primarily due to the decrease in product revenue and overhead costs, partially offset by higher excess and obsolete inventory provision compared to the prior year.

The increase in excess and obsolete inventory provision reflects lower expected future demand for certain older product lines for the fiscal year 2020 as we transition to newer technologies.

The increase in cost of services revenue is in line with the service revenue growth and due to our continued investment in our cloud service offerings to improve our customer experience and to enhance our security profile, as well as Verisure NRE service costs, offset by cost optimizations implemented during the year.

Cost of products revenue decreased for the year ended December 31, 2019, due primarily to a decline in product revenue compared to the prior year.

Cost of services revenue increased for the year ended December 31, 2019, in line with the service revenue growth and due to our continued investment in our cloud service offerings to improve our customer experience and to enhance our security profile, offset by cost optimizations implemented during the year.

The following table presents gross margin for the periods indicated:

Year Ended December 31,

2020 % Change 2019 % Change 2018

(In thousands, except percentage data)

Gross profit:

Products $ 20,963 31.9 % $ 15,894 (78.3) % $ 73,090

Services 34,426 72.9 % 19,910 4.9 % 18,985

Total gross profit $ 55,389 54.7 % $ 35,804 (61.1) % $ 92,075

Gross profit percentage:

Products 7.4 % 4.9 % 17.1 %

Services 47.6 % 42.6 % 50.2 %

Total gross profit percentage 15.5 % 9.7 % 19.8 %

Gross margin increased for the year ended December 31, 2020 compared to the prior year, due to a combination of both product and service margin increases.

The product margin increase is primarily due to decreased provisions for price protection and marketing expenditures that are deemed to be reductions of revenue and decreased product overhead, partially offset by higher excess and obsolete inventory provision.

Service margin increased for year ended December 31, 2020, compared to the prior year, primarily due to an increase in paid service revenue and cost optimizations implemented.

Gross margin decreased for the year ended December 31, 2019 compared to the prior year, due to a combination of both product and service margin declines.

The product margin decline is primarily due to increased marketing expenditures deemed to be a reduction of revenues, increased provisions for price protection that are deemed to be reductions of revenue, increased warranty costs, product overhead and freight-related costs, offset by less charges for excess or obsolete inventory.

Service margin decreased for the year ended December 31, 2019 compared to the prior year, primarily due to higher service cost growth which included the cost of the free 3-month and 12-month trials of Arlo Smart included in our new product offerings in fiscal 2019.

Cost of revenue increased for the year ended December 31, 2018 , due primarily to revenue growth compared to the prior year.

Gross margin decreased for the year ended December 31, 2018 compared to the prior year due primarily to higher channel marketing promotion activities deemed to be a reduction of revenue and due to an increase in inventory reserves for excess and obsolete products as well as excess materials from our original design manufacturers (“ODMs”).

The decrease was partially offset by higher revenue and product margin, mainly from the continued rollout of our Arlo Pro 2 camera.

During the fourth quarter of 2018, we experienced a decline in our gross margin mainly from increased marketing expenditures that are deemed to be a reduction in revenue.

Operating Expenses

For the year ended December 31, 2019 , our operating expenses, which reflect a full year as a standalone public company, were expected to increase compared to historical periods.

The full year of 2017 and first and second quarters of 2018, are based on carve-out financials and reflect the transactions which are directly attributable to Arlo and certain allocated costs, whereas third quarter and fourth quarter of 2018 and 2019 are based on our actual results for the periods as a standalone public company.

The first and second quarters of 2018, are based on carve-out financials and reflect the transactions which are directly attributable to Arlo and certain allocated costs, whereas third quarter and fourth quarter of 2018 and full years of 2019 and 2020 are based on our actual results for the periods as a standalone public company.

Research and Development

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Year Ended December 31,

2020 % Change 2019 % Change 2018

(In thousands, except percentage data)

Research and development expense $ 60,137 (13.3) % $ 69,384 18.0 % $ 58,794

Research and development expense increased for the year ended December 31, 2019 compared to the prior year due to increases of $2.5 million in personnel-related expenses and $8.3 million in corporate IT and facilities overhead.

Research and development expense decreased for the year ended December 31, 2020 compared to the prior year, due to decreases of $2.6 million in personnel-related expenses primarily as a result of the reduction in force implemented in the last quarter of 2019, and $4.1 million in IT and facility overhead, partially offset by an increase of $2.0 million in expenses related to outside professional services.

Also contributing to the reduction in Research and development expense, various research and development expenses amounting to $4.1 million were attributed to the Verisure NRE arrangement, and are classified as cost of service revenue in fiscal year 2020.

The increased expenditures on personnel-related expense and engineering projects were due to continuous investment in strategic focus areas, principally the expansion of our Arlo product and service offerings and the growth of our cloud platform capabilities.

The increase in corporate IT and facilities overhead is due to the fact that starting in late 2018 Arlo moved to separate facilities globally and for the whole of 2019 Arlo maintained its own facilities and IT infrastructures and systems globally as a standalone public company.

Research and development expense increased for the year ended December 31, 2018 compared to the prior year due to increases of $11.6 million in personnel-related expenses, $9.2 million in corporate IT and facilities overhead, $2.5 million in engineering projects and outside professional services, and $0.4 million in NETGEAR TSA related expense.

The increased expenditures on personnel-related expense, engineering projects and outside professional services were due to continuous investment in strategic focus areas, principally the expansion of our Arlo product and service offerings and the growth of our cloud platform capabilities.

The increase in IT and facilities overhead is due to the fact that starting in late 2018 Arlo moved to separate facilities globally and for the full year of 2019 Arlo maintained its own facilities and IT infrastructures and systems globally as a standalone public company.

Sales and Marketing

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Year Ended December 31,

2020 % Change 2019 % Change 2018

(In thousands, except percentage data)

Sales and marketing expense $ 49,064 (13.9) % $ 56,985 8.4 % $ 52,593

Sales and marketing expense increased for the year ended December 31, 2019 compared to the prior year, primarily due to an increase in outside professional services of $2.0 million, corporate IT and facilities overhead of $2.7 million, and personnel-related expenses of $1.2 million.

The increases were partially offset by a decrease NETGEAR TSA related expenses of $1.5 million.

The increased in corporate IT and facilities overhead is due to the fact that starting in late 2018 Arlo moved to separate facilities globally and for the whole of 2019 Arlo maintained its own facilities and IT infrastructures and systems globally as a standalone public company.

Sales and marketing expense increased for the year ended December 31, 2018 compared to the prior year, primarily due to an increase in personnel-related expenses of $7.7 million, digital advertising, media and other costs of $7.1 million, IT and facilities overhead of $2.3 million, NETGEAR TSA related expense of $1.6 million, and sales freight out expenses of $0.7 million.

The increase was partially offset by a decrease in marketing expenditures of $1.1 million further to the launch of our Arlo Pro 2 camera in fiscal 2017.

Sales and marketing expense decreased for the year ended December 31, 2020 compared to the prior year, primarily due to decreases in personnel-related expenses of $5.5 million, outside professional services of $2.1 million, and IT and facility overhead of $2.1 million, partially offset by an increase in credit card processing fees of $1.0 million driven by the growth in sales from Arlo's direct to consumer store and paid accounts service revenue.

The decreases are as a result of a general reduction of headcount within sales and marketing as well as the transfer of our European sales and marketing team to Verisure on December 30, 2019, coupled with a reduction in travel related expense as a result of COVID-19 restrictions.

Sales and marketing expense increased for the year ended December 31, 2019 compared to the prior year, primarily due to an increase in outside professional services of $2.0 million, IT and facilities overhead of $2.7 million, and personnel-related expenses of $1.2 million.

The increases were partially offset by a decrease of $1.5 million in expenses related to NETGEAR Transition Service Agreement ("TSA").

The increase in IT and facilities overhead is due to the fact that starting in late 2018 Arlo moved to separate facilities globally and for the whole of 2019 Arlo maintained its own facilities and IT infrastructures and systems globally as a standalone public company.

General and Administrative

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Year Ended December 31,

2020 % Change 2019 % Change 2018

(In thousands, except percentage data)

General and administrative expense $ 51,096 7.3 % $ 47,624 68.8 % $ 28,209

General and administrative expense increased for the year ended December 31, 2019 compared to the prior year, primarily due to higher corporate IT and facilities overhead of $9.7 million, higher personnel-related expenditures of $6.0 million, higher legal and professional services of $5.3 million, and transaction costs of $1.9 million related to the disposal of our commercial operations in Europe, partially offset by $4.2 million decrease in NETGEAR TSA related expenses.

The increase in general and administrative expense was driven by the increase in related corporate IT and facilities overhead due to the fact that starting in late 2018 Arlo moved to separate facilities globally and for the whole of 2019 Arlo maintained its own facilities and IT infrastructures and systems globally, increased customary public company costs, including outside legal and audit fees, insurance and other costs as our company became a standalone public company since August 2018.

General and administrative expense increased for the year ended December 31, 2018 compared to the prior year, primarily due to higher personnel-related expenditures of $7.0 million, NETGEAR TSA related expense of $4.3 million, and higher legal and professional services of $1.8 million.

Refer to Overview for further detail about the NETGEAR TSA.

General and administrative expense increased for the year ended December 31, 2020 compared to the prior year, primarily due to higher personnel-related expenditures of $7.8 million, partially offset by decreases of $2.2 million in legal and professional services and $1.1 million of transaction costs related to the disposal of our commercial operations in Europe in the fourth quarter of 2019.

The increase in personnel-related expenditures were mainly driven by the $7.4 million stock-based compensation expense recognized for the voluntary forfeiture of certain options by our Chief Executive Officer in January 2020, partially offset by the reversal of the previously recognized stock-based compensation expense amounting to $1.2 million of unvested options and restricted stock units upon the separation of our former Chief Financial Officer in June 2020.

General and administrative expense increased for the year ended December 31, 2019 compared to the prior year, primarily due to higher IT and facilities overhead of $9.7 million, higher personnel-related expenditures of $6.0 million, higher legal and professional services of $5.3 million, and transaction costs of $1.9 million related to the disposal of our commercial operations in Europe, partially offset by $4.2 million decrease in NETGEAR TSA related expenses.

The increase in general and administrative expense was driven by the increase in related IT and facilities overhead due to the fact that starting in late 2018 Arlo moved to separate facilities globally and for the whole of 2019 Arlo maintained its own facilities and IT infrastructures and systems globally, increased customary public company costs, including outside legal and audit fees, insurance and other costs as our company became a standalone public company since August 2018.

Separation Expense

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Year Ended December 31,

2020 % Change 2019 % Change 2018

(In thousands, except percentage data)

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Separation expense consists primarily of charges for third-party advisory, consulting, legal and professional services, IT-related expenses, and other items that are incremental and one-time in nature related to our separation from NETGEAR.

There was a significant reduction in our separation expense in the fiscal year ended December 31, 2019 as we completed our Separation from NETGEAR on December 31, 2018.

To operate as a standalone company, we have incurred separation costs.

The significant reduction for fiscal years of 2020 and 2019 was as a result of the substantial completion of our Separation from NETGEAR effective December 31, 2018.

Gain on sale of business

Year Ended December 31,

2020 % Change 2019 % Change 2018

(In thousands, except percentage data)

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**Percentage change not meaningful.

Our disposal of our commercial operations in Europe generated a gain on sale of business for the year ended December 31, 2019 of $54.9 million in the fourth quarter of 2019.

There was no gain or loss for the year ended December 31, 2018.

Refer to Note 4 , Disposal of business , in Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K for a complete discussion of this disposal.

In the fourth quarter of 2019, we sold our commercial operations in Europe which resulted in a gain on sale of business of $54.9 million.

In the first quarter of 2020, we recognized an additional gain of $0.3 million as a result of the final working capital adjustment.

There was no gain on sale of business for the year ended December 31, 2018.

Refer to Note 4, Disposal of Business , in the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K for a complete discussion of this disposal.

Interest Income and Other Income (Expense), Net

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Year Ended December 31,

2020 % Change 2019 % Change 2018

(In thousands, except percentage data)

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During the year ended December 31, 2020, we earned interest income of $0.8 million from our cash equivalents and short-term investments.

Other income (expense), net increased for the year ended December 31, 2019 compared to the prior year, due primarily to Verisure TSA related income of $798 thousand and higher foreign currency transaction gains, mainly as a result of the U.S.

dollar strengthening against transaction currencies.

During the year ended December 31, 2018 , we earned interest income of $1.2 million from our cash proceeds from the IPO and from our cash equivalents and short-term investments.

Other income (expense), net decreased for the year ended December 31, 2018 compared to the prior year, due primarily to higher foreign currency transaction losses, mainly as a result of the U.S.

The reduction, compared to the prior year, is primarily due to the decrease in our short-term investments and cash and cash equivalents as we funded our operations and the decline in interest rates.

Other income (expense), net increased for the year ended December 31, 2020 compared to the prior year, primarily due to Verisure TSA related income of $4.0 million recognized in fiscal year 2020.

During the year ended December 31, 2019, we earned interest income of $2.7 million from our cash equivalents and short-term investments.

Other income (expense), net increased for the year ended December 31, 2019 compared to the prior year, primarily due to Verisure TSA related income of $0.8 million and higher foreign currency transaction gains, mainly as a result of the U.S.

dollar strengthening against transaction currencies.

We entered into a foreign currency hedging program during the third quarter of fiscal 2018, which effectively reduced volatility associated with hedged currency exchange rate movements.

For a detailed discussion of our hedging program and related foreign currency

contracts, refer to Note 7 , Derivative Financial Instruments , in Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K.

Provision for Income Taxes

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Year Ended December 31,

2020 % Change 2019 % Change 2018

(In thousands, except percentage data)

1 unchanged sentence

Effective tax rate (0.6) % (5.4) % (1.0) %

The increase in provision for income taxes for the year ended December 31, 2019 compared to 2018 was primarily due to higher foreign earnings in 2019 and gain on sale of certain assets related to the Company's commercial operations in Europe during the fourth quarter of 2019.

The decrease in provision for income taxes for the year ended December 31, 2020 compared to the prior year was primarily due to lower foreign earnings in 2020, resulting from the sale of our commercial operations in Europe during the fourth quarter of 2019.

Furthermore, 2019 included the gain on sale of certain assets related to the Company's commercial operations in Europe during the fourth quarter of 2019.

Losses incurred predominantly in the U.S continue to be subject to a full valuation allowance.

The decrease in provision for income taxes for the year ended December 31, 2018 compared to 2017 was primarily caused by the deemed repatriation of foreign earnings in 2017 following the 2017 U.S.

The negative 1.0% effective tax rate was a result of losses in the U.S for which the Company was not recognizing a tax benefit due to its full U.S federal and state valuation allowance.

The increase in provision for income taxes for the year ended December 31, 2019 compared to the prior year was primarily due to higher foreign earnings in 2019 and gain on sale of certain assets related to the Company's commercial operations in Europe during the fourth quarter of 2019.

Losses incurred predominantly in the U.S continue to be subject to a full valuation allowance.

Liquidity and Capital Resources

Following the completion of the IPO, our capital structure and sources of liquidity changed significantly from our historical capital structure as we became a standalone public company.

We are no longer participating in cash management and funding arrangements managed by NETGEAR.

Arlo maintained a separate cash management and financing function for our operations.

We have a history of losses and may continue to incur operating and net losses for the foreseeable future.

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As of December 31, 2020, we had cash, cash equivalents and short-term investments totaling $206.1 million.

In November 2019, we entered into a business financing agreement with Western Alliance Bank providing for a credit facility to up to $40.0 million and as of December 31, 2019, we have not borrowed against this credit facility.

Refer to Note 10 .

Debt in the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K for further details on such business financing agreement.

In December 2019, we received a total of $75.2 million from Verisure for the disposal of our commercial operations in Europe, including a $20.0 million prepayment for product purchases and a $2.5 million installment payment for the NRE Services under the Supply Agreement.

As of December 31, 2020, 23.3% of our cash and cash equivalents were held outside of the U.S.

Starting in 2018, as a result of the Tax Cuts and the Jumpstart Our Business Startups Act of 2017 (the “Tax Act”), due to the one-time transition tax on un-repatriated earnings, the tax impact is generally immaterial should we repatriate our cash from foreign

Starting in 2018, as a result of the Tax Act, the tax impact on the repatriation of foreign earnings is generally immaterial.

The cash and cash equivalents balance outside of the U.S is subject to fluctuation based on the settlement of intercompany balances.

Based on our current plans, business financing agreement with Western Alliance Bank, and market conditions, we believe that such sources of liquidity will be sufficient to satisfy our anticipated cash requirements for at least the next 12 months.

However, in the future, including sooner as may be anticipated, we may require or desire additional funds to support our operating expenses and capital requirements or for other purposes, such as acquisitions, and may seek to raise such additional funds through public or private equity or debt financings or collaborative agreements or from other sources.

To preserve the tax-free treatment of our separation from NETGEAR, we have agreed in the tax matters agreement with NETGEAR to certain restrictions on our business, which generally will be effective during the two-year period following the Distribution that could limit our ability to pursue certain transactions including equity issuances.

In November 2019, we entered into a business financing agreement with Western Alliance Bank providing for a credit facility of up to $40.0 million and as of December 31, 2020, we have not borrowed against this credit facility.

Refer to Note 10.

Debt in the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K for further details on such business financing agreement.

Based on our current plans, the business financing agreement with Western Alliance Bank, and market conditions, we believe that such sources of liquidity will be sufficient to satisfy our anticipated cash requirements for at least the next 12 months.

However, in the future we may require or desire additional funds to support our operating

expenses and capital requirements or for other purposes, such as acquisitions, and may seek to raise such additional funds through public or private equity or debt financings or collaborative agreements or from other sources.

However, the COVID-19 pandemic continues to rapidly evolve and has already resulted in a significant disruption of global financial markets.

If the disruption persists and deepens, we could experience an inability to access additional capital, which could in the future negatively affect our capacity to support our operating expenses and capital requirements or to make investments for other purposes, such as acquisitions.

We have no commitments to obtain such additional financing and cannot assure you that additional financing will be available at all or, if available, that such financing would be obtainable on terms favorable to us and would not be dilutive.

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Year Ended December 31,

2020 2019 2018

(In thousands)

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Operating activities

Net cash used in operating activities increased by $55.7 million for the year ended December 31, 2020 compared to the prior year.

This increase comprised a $55.8 million reduction in adjusted net loss for cash flows, offset by an increase in working capital used in operations of $111.5 million, mainly due to a reduction in accounts payable in 2020, compared to an increase in accounts payable in 2019 and an initiative to right-size inventory in 2019 which was not repeated in 2020.

Net cash provided by operating activities increased by $26.9 million for the year ended December 31, 2019 compared to the prior year, due primarily to improved working capital management, offset by a $55.0 million year over year decrease in the adjusted net loss from operations.

Our cash inflow from changes in assets and liabilities increased by $81.9 million year over year as a result of increased accounts receivable collections, prepayments from Verisure product purchases and NRE services under the Supply Agreement and lower inventory balance.

Net cash used in operating activities decreased by $21.3 million for the year ended December 31, 2018 compared to the prior year, due primarily to the favorable net working capital changes offset by the net loss incurred.

Changes in operating activities also reflected the movements of the balances for Statements of Cash Flows purposes since the balances contributed by NETGEAR on or before the initial public offering reflects the contributed balances to us as per the master separation agreement between Arlo and NETGEAR and related documents governing the Contribution.

Our days sales outstanding (“DSO”) decreased to 97 days as of December 31, 2019 as compared to 125 days as of December 31, 2018 .

Inventory decreased to $68.6 million as of December 31, 2019 from $124.8 million as of December 31, 2018 , primarily due to better inventory management.

As a result, ending inventory turns were 5.9 x in the three months ended December 31, 2019 down from 3.6 x turns in the three months ended December 31, 2018 .

Our accounts payable increased to $111.7 million as of December 31, 2019 from $82.5 million as of December 31, 2018 , primarily as a result of extended payment terms with our suppliers.

Our days sales outstanding (“DSO”) decreased to 64 days as of December 31, 2020 as compared to 97 days as of December 31, 2019, primarily as a result of customer mix, an increase in service revenue and growth in sales from Arlo's direct to consumer store, all of which have shorter payment terms.

Typically, our DSO in the fourth quarter is higher due to seasonal payment terms provided to our larger customers, while service revenue is typically a lower percentage of our revenue in the fourth quarter.

Inventory decreased to $64.7 million as of December 31, 2020 from $68.6 million as of December 31, 2019, primarily due to lower inventory purchases.

Our ending inventory turns were 5.0x in the three months ended December 31, 2020 down from 5.9x turns in the three months ended December 31, 2019, primarily as a result of a reduction in product shipments which was not offset by a corresponding reduction in inventory.

Our accounts payable decreased to $62.2 million as of December 31, 2020 from $111.7 million as of December 31, 2019, primarily as a result of lower inventory purchases and earlier payments to suppliers for purchases made.

Investing activities

Net cash used in investing activities increased by $80.2 million for the year ended December 31, 2020 compared to the prior year, primarily due to a reduction in proceeds from maturity of short-term investments of $30.3 million and a reduction in proceeds from sale of our commercial operations in Europe in 2019 of $52.7 million, partially offset by less purchases of property and equipment of $2.8 million due to the completion of leasehold improvements in 2019 at our San Jose headquarters.

Net cash provided by investing activities increased by $147.5 million for the year ended December 31, 2019 compared to the prior year, primarily due to the more maturity of short-term investments in the amount of $55.0 million, less purchases of short-term investments of $24.9 million, less purchases of property equipment of $15.0 million, and proceeds from sale of our commercial operations in Europe in the amount of $52.7 million.

Net cash used in investing activities increased by $67.0 million for the year ended December 31, 2018 compared to the prior year, primarily due to the purchase of short-term investments of $54.6 million and the increased capital expenditures as we implement certain new systems, including infrastructure and an enterprise resource planning system.

In the year ended December 31, 2017 , we made a $0.7 million payment in connection with our Placemeter acquisition.

Financing activities

Net cash used in financing activities was $38 thousand in the year ended December 31, 2019 represented by proceeds from ESPP contributions of $1.8 million , partially offset by $1.9 million in tax withholdings from restricted stock unit releases.

Net cash provided by financing activities was $244.3 million in the year ended December 31, 2018 , primarily due to net proceeds from IPO of $173.4 million and net investment from parent of $70.9 million .

Prior to the completion of the IPO, because cash and cash equivalents were held by NETGEAR at the corporate level and were not attributable to Arlo, cash flows related to financing activities primarily reflect changes in Net parent investment.

Net cash used in financing activities was $23 thousand for the year ended December 31, 2020 and comprised withholding tax from restricted stock unit releases of $4.78 million, offset by proceeds from Employee Stock Purchase Plan contributions and exercises of stock options of $4.76 million.

Net cash used in financing activities was $38 thousand in the year ended December 31, 2019 and comprised proceeds from Employee Stock Purchase Plan contributions of $1.8 million, offset by $1.9 million in tax withholdings from restricted stock unit releases.

Our backlog consists of products for which customer purchase orders have been received and that are scheduled or in the process of being scheduled for shipment.

As of December 31, 2020, we had a backlog of $5.7 million, compared to $5.4 million as of December 31, 2019 and $18.9 million as of December 31, 2018.

As we typically fulfill orders received within a relatively short period (e.g., within one week for our top three customers) after receipt, our revenue in any fiscal year depends primarily upon orders booked and the availability of supply of our products in that year.

As we typically fulfill orders received within a relatively short period after receipt, our revenue in any fiscal year depends primarily upon orders booked and the availability of supply of our products in that year.

In addition, most of our backlog is subject to rescheduling or cancellation with minimal penalties.

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Payments due by period

Less Than 1-3 3-5 More Than

Total 1 Year Years Years 5 Years

(In thousands)

1 unchanged sentence

Purchase obligations 19,532 19,532 — — —

$ 55,353 $ 25,463 $ 10,747 $ 7,645 $ 11,498

Operating leases

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The amounts presented are consistent with contractual terms and are not expected to differ significantly, unless a substantial change in our headcount requires us to exit an office facility early or expand our occupied space.

For the year ended December 31, 2019 , rent expense was $7 million .

For the year ended December 31, 2017 and six months ended July 1, 2018, rent expense reflected allocations from NETGEAR and may not be indicative of our results.

For the years ended December 31, 2020 and 2019, rent expense was $7.0 million and $7.0 million, respectively.

For the six months ended July 1, 2018, rent expense reflected allocations from NETGEAR and may not be indicative of our results.

Rent expense was $1.4 million after the Separation through December 31, 2018.

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We do not expect to reduce our liabilities for uncertain tax positions in any jurisdiction, where the impact would affect the statement of operations, in the next 12 months.

We do not estimate any long-term liability related to a one-time transaction tax that resulted from the passage of the Tax Act.

Off-Balance Sheet Arrangements

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Products sold come with a standard twelve month warranty.

Verisure assumes responsibilities for all warranty claims, returns on products and certain technical support to the end users.

We provide technical support for paid subscription services where Verisure can not resolve the issue.

Verisure assumes responsibilities for all warranty claims, returns of products and certain technical support provided to end users.

We provide technical support for paid subscription services where Verisure cannot resolve the issue.

Verisure is responsible for any marketing and promotion of our products and services sold in Europe.

Products are priced at a cost plus markup based on markups specified in the agreement and that price varies based on the cost of the product.

The paid subscription services and basic services pricing is based on the number of users monthly and is priced at a cost plus markup specified in the Supply Agreement that varies based on the user and service type.

The paid subscription service and basic service pricing is based on the number of users monthly and is priced at a cost plus markup specified in the Supply Agreement, which varies based on the user and service type.

T he transaction price for products and paid subscription services is entirely variable because the consideration is dependent on the actual costs.

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We recognize variable consideration for products upon delivery and for services when the monthly service is rendered for paid subscription services and basic services.

The non-refundable prepayment does not relate to future goods or services, as such no further assessment of material rights is required.

The non-refundable product prepayments does not relate to future goods or services, as such no further assessment of material rights is required.

Further, as the transfer of products is at the discretion of the customer (i.e.

when Verisure issues a PO), a significant financing component does not exist as it relates to the prepayment.

We also expect that prepayment will be fully utilized by Verisure within one year, hence, no additional accounting consideration is necessary for breakage.

when Verisure issues a PO), a significant financing component does not exist as it relates to the product prepayments.

We also expect that the product prepayments will be fully utilized by Verisure within 12 to 18 months, hence, no additional accounting consideration is necessary for breakage.

We also concluded that we are acting as the principal in the Supply Agreement and determined that revenue should be presented gross.

Non-recurring Engineering ("NRE") Arrangement - Verisure

Non-recurring Engineering Arrangement - Verisure

The Supply Agreement also provides for certain development services under an SOW to Verisure ("NRE arrangement") as part of the disposal of our commercial operations in Europe.

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Sales Incentives

We accrue for sales incentives as a marketing expense if we receive an identifiable benefit in exchange and can reasonably estimate the fair value of the identifiable benefit received;

We accrue for sales incentives offered to customers as a marketing expense if we receive an identifiable benefit in exchange and can reasonably estimate the fair value of the identifiable benefit received;

otherwise, it is recorded as a reduction to revenue.

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We would record any impairment charge within earnings in the consolidated statements of operations.

A quantitative assessment of goodwill was performed on the first day of the fourth quarter of fiscal 2019 .

We identified that we had one reporting unit for the purpose of goodwill impairment testing and the reporting unit is at the same level as the operating segment and reportable segment.

We utilized our market capitalization as a proxy for fair value of the business and compared it to the carrying amount as of October 1, 2019 .

Based on the results of the quantitative assessment, the respective fair value was substantially in excess of the carrying amount by $68.0 million , or 38% .

We updated our quantitative test as of December 31, 2019 at which time the fair value of the business was substantially in excess of the carrying amount by $115.7 million , or 57% .

No goodwill impairment was recognized for the years ended December 31, 2019 and 2018 .

However, included in our accounting for the disposal of our commercial operations in Europe was a derecognition of $4.6 million of goodwill associated with the disposal of our commercial operations in Europe.

We do not believe it is likely that there will be a material change in the estimates or assumptions we use to test for impairment loss on goodwill.

However, if the actual result is not consistent with our estimates or assumptions, we may be exposed to an impairment charge that could be material.

Stock-based compensation

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We measure stock-based compensation at the grant date based on the fair value of the award.

The fair value of stock options and the shares offered

under the employee stock purchase plan is estimated using the Black-Scholes option pricing model.

The fair value of stock options and the shares offered under the employee stock purchase plan is estimated using the Black-Scholes option pricing model.

Estimated compensation cost relating to restricted stock units ("RSUs") is based on the closing fair market value of NETGEAR’s common stock on the date of grant.

Equity awards granted under our own stock-based compensation plans on or after the completion of the IPO are comprised of performance-based stock options (the “PSOs”), stock options, and RSUs.

We use the fair value method of accounting for its equity awards granted to employees and measures the cost of employee services received in exchange for the stock-based awards.

We recognize these compensation expenses generally on a straight-line basis over the requisite service period of the award.

The fair value of stock options and PSOs is estimated on the grant or offering date using the Black-Scholes option pricing model and the forfeitures recorded as they occur.

The fair value of RSUs is measured on the grant date based on the closing fair market value of our common stock.

Equity awards granted by the Company under its own stock-based compensation plans on or after the completion of the IPO are comprised of performance-based stock options (the “PSOs”), stock options, RSUs, performance RSUs ("PSUs"), and market-based performance RSUs ("MPSUs").

The Company uses the fair value method of accounting for its equity awards granted to employees and measures the cost of employee services received in exchange for the stock-based awards.

The Company recognizes this compensation expense generally on a straight-line basis over the requisite service period of the award.

The fair value of stock options and PSOs is estimated on the grant or offering date using the Black-Scholes option pricing model and the forfeitures are recorded as they occur.

The fair value of RSUs and PSUs is measured on the grant date based on the closing fair market value of the Company’s common stock.

The Company utilizes a Monte Carlo pricing model customized to the specific provisions of the 2018 Plan to value the MPSUs awards on the grant date.

The fair value determined using the Monte Carlo simulation model varies based on the assumptions used for the expected stock price volatility, the correlation coefficient between the Company and Russell 2000 Index, risk-free interest rates, and dividend yield.

The stock-based compensation cost is recognized ratably over the period during which an employee is required to provide service in exchange for the awards, usually the vesting period, which is generally four years for stock options and three to four years for RSUs.

For PSOs, stock-based compensation expense of individual performance milestone is recognized over the expected performance achievement period when the achievement becomes probable.

For PSOs and PSUs, stock-based compensation expense associated with individual performance milestones is recognized over the expected performance achievement period when the achievement becomes probable.

For MPSUs, stock-based compensation expense is recognized ratably over the performance period subject to achievement of market conditions.

Our 2018 Employee Stock Purchase Plan (“ESPP”) is intended to provide employees with the opportunity to purchase our common stock through accumulated payroll deductions at the end of specified purchase period.

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As we expand internationally, we will face increased complexity in determining the appropriate tax jurisdictions for revenue and expense items.

Our policy is to adjust these reserves when facts and circumstances change, such as the closing of a tax audit or refinement of an estimate.

The provision for income taxes includes the effects of any accruals that we believe are appropriate, as well as the related net interest and penalties.

The Tax Act introduced the global intangible low-taxed income (“GILTI”) provisions effective in 2018, which generally impose a tax on the net income earned by foreign subsidiaries of U.S company in excess of a deemed return on their tangible assets.

The provision for income taxes includes the effects of any accruals that we believe are appropriate, as well as the related interest and penalties.

The Tax Act introduced the GILTI provisions effective in 2018, which generally impose a tax on the net income earned by foreign subsidiaries of U.S company in excess of a deemed return on their tangible assets.

We recognize the tax on GILTI as a period cost when the tax is incurred.

Recent Accounting Pronouncements

For a complete description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on financial condition and results of operations, refer to Note 2 , Summary of Significant Accounting Policies , in Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K.

For a complete description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on financial condition and results of operations, refer to Note 2, Summary of Significant Accounting Policies , in the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K.

Emerging Growth Company Status

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

What changed 10-K

Item 7. Management’s Discussion and Analysis