Arlo Technologies, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-looking Statements This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995. Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. For example, the words “believes,” “anticipates,” “plans,” “expects,” “intends,” “could,” “may,” “will,” and similar expressions are intended to identify forward-looking statements, including statements concerning our business and the expected performance characteristics, specifications, reliability, market acceptance, market growth, specific uses, user feedback, market position of our products and technology and the potential adverse impact of the COVID-19 pandemic on our business and operations. Our actual results and the timing of certain events may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a discrepancy include, but are not limited to, those discussed in “Part II—Item 1A—Risk Factors” and “Liquidity and Capital Resources” below. All forward-looking statements in this document are based on information available to us as of the date hereof and we assume no obligation to update any such forward-looking statements. The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and the accompanying notes contained in this quarterly report. Unless expressly stated or the context otherwise requires, the terms “we,” “our,” “us,” “the Company,” and “Arlo” refer to Arlo Technologies, Inc. and our subsidiaries. Business and Executive Overview 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. Since the launch of our first product in December 2014, we have shipped over 20.6 million smart connected devices, and as of June 27, 2021, our smart platform had approximately 5.5 million cumulative registered accounts across more than 100 countries around the world. We conduct business across three geographic regions-the Americas; Europe, Middle-East and Africa (“EMEA”); 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 32.5% and 25.2% of our revenue for the three months ended June 27, 2021 and June 28, 2020, respectively, and 35.9% and 25.7% of our revenue for the six months ended June 27, 2021 and June 28, 2020, respectively. For the three months ended June 27, 2021 and June 28, 2020, we generated revenue of $98.6 million and $66.6 million, respectively, representing a year-over-year increase of 47.9%. For the six months ended June 27, 2021 and June 28, 2020, we generated revenue of $181.1 million and $132.1 million, respectively, representing a year-over-year increase of 37.1%. Loss from operations were $25.8 million and $30.3 million for the three months ended June 27, 2021 and June 28, 2020, respectively. Loss from operations were $37.3 million and $71.2 million for the six months ended June 27, 2021 and June 28, 2020, 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 paid account bases. We believe that the growth of our business is dependent on many factors, including our ability to innovate and launch successful new products on a timely basis and grow our installed base, to increase subscription-based recurring revenue, to invest in brand awareness and channel partnerships and to continue our global expansion. We expect to maintain our investment in research and development going forward as we continue to introduce new and innovative products and services to enhance the Arlo platform. 36 Table of Contents Key Business Metrics In addition to the measures presented in our unaudited condensed consolidated financial statements, we use the following key metrics to evaluate our business, measure our performance, develop financial forecasts and make strategic decisions. 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. We believe that any such inaccuracies or adjustments are immaterial unless otherwise stated. As of June 27, 2021 % Change June 28, 2020 (In thousands, except percentage data) Cumulative registered accounts 5,527 22.3 % 4,518 Cumulative paid accounts 695 133.2 % 298 Cumulative Registered Accounts . We believe that our ability to increase our user base is an indicator of our market penetration and growth of our business as we continue to expand and innovate our Arlo platform. We define our registered accounts at the end of a particular period as the number of unique registered accounts on the Arlo platform as of the end of such particular period. 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 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). 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. COVID-19 Update 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 component shortages, extended transit times, labor shortages, factory uptime, freight capacity, inflated freight pricing and increased component and finished goods costs; 37 Table of Contents • deferment of customer spending due to economic uncertainty; • decreased productivity due to travel bans, work-from-home policies or shelter in place orders; and • a slow-down in the global economy or a credit crisis. We continue to closely monitor developments and are taking steps to mitigate the potential risks related to the COVID-19 pandemic to us, our employees and our customers. The extent of the impact of the COVID-19 pandemic on our business operations will depend on future developments, including the duration of the pandemic, the broader implications of the macro-economic recovery and the impact on overall customer demand, all of which are uncertain and cannot be predicted. Our priorities and actions during the COVID-19 pandemic continue to be focused on protecting the health and safety of all those we serve, our employees, our customers, our suppliers and our communities, including implementing continuous updates to our health and safety policies and processes and progress made through vaccinations. We continue to instruct all but a limited number of our global workforce to work remotely as a precautionary measure intended to minimize the risk of the virus to them and the communities in which we operate, while we continue to focus 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 presented by the COVID-19 pandemic. We also continue to work with our suppliers to address any supply chain disruptions, which might include larger component backlogs, component cost increases, 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. As a result, we have experienced component shortages, including longer lead times for components and supply constraints, that have affected both our ability to meet scheduled product deliveries and worldwide demand for our products. Also, as a result of the COVID-19 pandemic, our supply chain partners are limited by production capacity, constrained by material availability, labor shortages, factory uptime and freight capacity, each of which constrains our ability to capitalize fully on end market demand. As of June 27, 2021, international freight capacity has dropped, causing air and ocean freight rates to materially increase. Furthermore, transit times have also increased, causing us to rely more on air freight in order to meet our customers' demands. For the three and six months ended June 27, 2021, we saw an 89% increase in freight-in expense compared to the prior year periods, respectively, as a result of the higher sea and air freight rates and component shortages which necessitated use of air freight to meet customer requested delivery dates. We expect supply chain constraints to exist through 2021 and potentially beyond. While we have been successful in navigating COVID-19 related challenges to date, any further disruptions brought about by the COVID-19 pandemic to our supply chain and operations could have a significant negative impact on our net revenue, gross and operating margin performance. In addition, as a result of the COVID-19 pandemic, 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 our hedging instruments, among others. During the second quarter of 2021, we evaluated our existing real estate lease portfolio in light the COVID-19 pandemic and its impact on the changing nature of office space use by our workforce. This evaluation included the decision to sublease our office space in San Jose, California. As a result, we recorded an impairment charge of $9.1 million, which includes $6.8 million associated with the right-of-use assets and $2.3 million associated with other lease related property and equipment assets, for the three and six months ended June 27, 2021. Refer to Note 4, Balance Sheet Components , for further information about the impairment of the right-of-use asset and long-lived assets. We continue to be focused on navigating these recent challenges presented by the COVID-19 pandemic 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, subleasing excess office space, 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. 38 Table of Contents Results of Operations We operate as one operating and reportable segment. The following table sets forth, for the periods presented, the unaudited condensed consolidated statements of operations data, which we derived from the accompanying unaudited condensed consolidated financial statements: Three Months Ended Six Months Ended June 27, 2021 June 28, 2020 June 27, 2021 June 28, 2020 (In thousands, except percentage data) Revenue: Products $ 73,311 74.4 % $ 49,603 74.4 % $ 133,072 73.5 % $ 100,326 76.0 % Services 25,260 25.6 % 17,029 25.6 % 48,055 26.5 % 31,756 24.0 % Total revenue 98,571 100.0 % 66,632 100.0 % 181,127 100.0 % 132,082 100.0 % Cost of revenue: Products 62,019 62.9 % 51,186 76.9 % 109,176 60.3 % 103,374 78.3 % Services 10,383 10.6 % 9,957 14.9 % 19,975 11.0 % 19,266 14.6 % Total cost of revenue 72,402 73.4 % 61,143 91.8 % 129,151 71.3 % 122,640 92.9 % Gross profit 26,169 26.6 % 5,489 8.2 % 51,976 28.7 % 9,442 7.1 % Operating expenses: Research and development 16,251 16.5 % 14,192 21.3 % 31,042 17.1 % 29,435 22.3 % Sales and marketing 12,459 12.6 % 11,713 17.6 % 23,666 13.1 % 22,751 17.2 % General and administrative 13,559 13.8 % 9,837 14.8 % 24,786 13.7 % 28,621 21.7 % Impairment charges 9,116 9.2 % — — % 9,116 5.0 % — — % Separation expense 605 0.6 % 82 0.1 % 659 0.4 % 161 0.1 % Gain on sale of business — — % — — % — — % (292) (0.2) % Total operating expenses 51,990 52.7 % 35,824 53.8 % 89,269 49.3 % 80,676 61.1 % Loss from operations (25,821) (26.2) % (30,335) (45.5) % (37,293) (20.6) % (71,234) (53.9) % Interest income 3 — % 151 0.2 % 27 — % 686 0.5 % Other income (expense), net 2,662 2.7 % 1,111 1.7 % 3,571 2.0 % 2,294 1.8 % Loss before income taxes (23,156) (23.5) % (29,073) (43.6) % (33,695) (18.6) % (68,254) (51.7) % Provision for income taxes 164 0.2 % 183 0.3 % 344 0.2 % 328 0.2 % Net loss $ (23,320) (23.7) % $ (29,256) (43.9) % $ (34,039) (18.8) % $ (68,582) (51.9) % 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 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 an NRE arrangement as part of the disposal of our commercial operations in Europe in the fourth quarter of 2019. 39 Table of Contents 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. A significant portion of our marketing expenditure is with customers and is deemed to be a reduction of revenue under authoritative guidance for revenue recognition. Under the Supply Agreement that we entered into with Verisure in 2019 (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 for an initial term of five years. During the five-year period commencing January 1, 2020, Verisure has an aggregate product purchase commitment of $500.0 million. As of June 27, 2021, $89.7 million of the purchase commitment has been fulfilled. The Supply Agreement also provides for certain NRE services to Verisure, including developing certain custom products specified by Verisure in exchange for an aggregate of $13.5 million, payable in installments upon meeting certain development milestones. As of June 27, 2021, Verisure has paid $11.8 million for these NRE services. For the three and six months ended June 27, 2021, the Company recognized service revenue of $2.0 million and $3.5 million, respectively, for these NRE services. For the three and six months ended June 28, 2020, the Company recognized service revenue of $2.3 million and $3.2 million, respectively, for these NRE services. We conduct business across three geographic regions: Americas, EMEA, and APAC. We generally base revenue by geography on the ship-to location of the customer for device sales and device location for service sales. Three Months Ended Six Months Ended June 27, 2021 % Change June 28, 2020 June 27, 2021 % Change June 28, 2020 (In thousands, except percentage data) Americas $ 66,681 30.7 % $ 50,999 $ 116,317 15.0 % $ 101,169 Percentage of revenue 67.6 % 76.5 % 64.2 % 76.6 % EMEA 25,101 122.9 % 11,263 49,692 168.3 % 18,521 Percentage of revenue 25.5 % 16.9 % 27.4 % 14.0 % APAC 6,789 55.4 % 4,370 15,118 22.0 % 12,392 Percentage of revenue 6.9 % 6.6 % 8.4 % 9.4 % Total revenue $ 98,571 47.9 % $ 66,632 $ 181,127 37.1 % $ 132,082 Revenue for the three and six months ended June 27, 2021 increased 47.9% and 37.1%, compared to the prior year periods, respectively. The increase was primarily driven by an increase in product shipments, higher 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 $8.2 million, or 48.3%, and $16.3 million, or 51.3%, for the three and six months ended June 27, 2021 compared to the prior year periods, respectively, primarily due to increased paid accounts. Cost of Revenue Cost of revenue consists of both product costs and costs of service. Product costs primarily consist of: 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, IT and facilities overhead, warranty costs associated with returned goods, write-downs for excess and obsolete inventory, royalties to third parties; 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, 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 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 40 Table of Contents 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. We also outsource certain components of the required infrastructure to support our cloud-based back-end IT infrastructure. We believe this outsourcing strategy allows us to better manage our product and services costs and gross margin. The following table presents cost of revenue and gross margin for the periods indicated: Three Months Ended Six Months Ended June 27, 2021 % Change June 28, 2020 June 27, 2021 % Change June 28, 2020 (In thousands, except percentage data) Cost of revenue: Products $ 62,019 21.2 % $ 51,186 $ 109,176 5.6 % $ 103,374 Services 10,383 4.3 % 9,957 19,975 3.7 % 19,266 Total cost of revenue $ 72,402 18.4 % $ 61,143 $ 129,151 5.3 % $ 122,640 Cost of products revenue increased for the three and six months ended June 27, 2021, primarily due to the increase in product revenue, partially offset by a decrease in warranty costs and excess and obsolete inventory provision, compared to the prior year periods. The decrease in warranty cost is a result of a lower scrap rate driven by increased refurbished product sales, lower returns and fewer product transitions. The decrease in excess and obsolete inventory provisions is due to fewer product transitions and more effective inventory management. Cost of services revenue stayed relatively flat for the three and six months ended June 27, 2021 compared to the prior year periods despite service revenue increasing, due to cost optimizations implemented on our platform and growth in paid service revenue which has a higher gross margin than the other components of service revenue. Gross Margin The following table presents gross margin for the periods indicated: Three Months Ended Six Months Ended June 27, 2021 % Change June 28, 2020 June 27, 2021 % Change June 28, 2020 (In thousands, except percentage data) Gross profit: Products $ 11,292 813.3 % $ (1,583) $ 23,896 884.0 % $ (3,048) Services 14,877 110.4 % 7,072 28,080 124.8 % 12,490 Total gross profit $ 26,169 376.8 % $ 5,489 $ 51,976 450.5 % $ 9,442 Gross profit percentage: Products 15.4 % (3.2) % 18.0 % (3.0) % Services 58.9 % 41.5 % 58.4 % 39.3 % Total gross profit percentage 26.6 % 8.2 % 28.7 % 7.1 % Gross margin increased for the three and six months ended June 27, 2021 compared to the prior year periods, due to a combination of both product and service margin increases. The product margin increase is primarily due to decreased provisions for price protection, sales returns and marketing expenditures that are deemed to be reductions of revenue, decreased warranty costs and a lower excess and obsolete inventory provision. The service margin increase is primarily due to an increase in paid service revenue coupled with various cost optimizations implemented. Operating Expenses Research and Development 41 Table of Contents 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. The following table presents research and development expense for the periods indicated: Three Months Ended Six Months Ended June 27, 2021 % Change June 28, 2020 June 27, 2021 % Change June 28, 2020 (In thousands, except percentage data) Research and development expense $ 16,251 14.5 % $ 14,192 $ 31,042 5.5 % $ 29,435 Research and development expense increased for the three months ended June 27, 2021, compared to the prior year period, primarily due to an increase of $2.2 million in personnel-related expenses. Research and development expense increased for the six months ended June 27, 2021, compared to the prior year period, primarily due to an increase of $3.0 million in personnel-related expenses, partially offset by a decrease of $1.6 million in corporate IT and facility overhead. Also, certain research and development expenses amounting to $1.0 million and $2.1 million, respectively, for the three and six months ended June 27, 2021, and $1.2 million and $1.8 million, respectively, for the three and six months ended June 28, 2020 were attributed to the Verisure NRE arrangement, and are classified as cost of service revenue. Sales and Marketing Sales and marketing expense consists primarily of personnel expense for sales and marketing staff; technical support expense; advertising; trade shows; corporate communications and other marketing expense; product marketing expense; IT and facilities overhead; outbound freight costs; and credit card processing fees. 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. The following table presents sales and marketing expense for the periods indicated: Three Months Ended Six Months Ended June 27, 2021 % Change June 28, 2020 June 27, 2021 % Change June 28, 2020 (In thousands, except percentage data) Sales and marketing expense $ 12,459 6.4 % $ 11,713 $ 23,666 4.0 % $ 22,751 Sales and marketing expense increased for the three months ended June 27, 2021, compared to the prior year period, primarily due to an increase of $0.5 million in personnel-related expenses and an increase of $0.3 million in credit card processing fees. Sales and marketing expense increased for the six months ended June 27, 2021, compared to the prior year period, primarily due to an increase of $1.2 million in personnel-related expenses and an increase of $0.6 million in credit card processing fees, partially offset by a decrease of $0.8 million in marketing expenditures. General and Administrative 42 Table of Contents 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 stay relatively flat in absolute dollars but to fluctuate as a percentage of our revenue in future periods based on fluctuations in our revenue and the timing of such expense. The following table presents general and administrative expense for the periods indicated: Three Months Ended Six Months Ended June 27, 2021 % Change June 28, 2020 June 27, 2021 % Change June 28, 2020 (In thousands, except percentage data) General and administrative expense $ 13,559 37.8 % $ 9,837 $ 24,786 (13.4) % $ 28,621 General and administrative expense increased for the three months ended June 27, 2021, compared to the prior year period, primarily due to an increase of $4.1 million in personnel-related expenditures, partially offset by a decrease of $0.3 million in corporate IT and facility overhead. General and administrative expense decreased for the six months ended June 27, 2021, compared to the prior year period, primarily due to a decrease of $2.1 million in personnel-related expenditures partially brought about by the one-time charge for stock-based compensation expense recognized in the first quarter of 2020 upon the voluntary forfeiture of our CEO's stock options in January 2020, $0.8 million of Verisure transaction costs recognized in the first half of 2020, and a decrease of $0.5 million in corporate IT and facility overhead. Impairment Charges The following table presents impairment charges for the periods indicated: Three Months Ended Six Months Ended June 27, 2021 % Change June 28, 2020 June 27, 2021 % Change June 28, 2020 (In thousands, except percentage data) Impairment charges $ 9,116 ** $ — $ 9,116 ** $ — During the second quarter of 2021, we reviewed certain of our right-of-use assets and other lease-related assets for impairment in conjunction with our decision to sublease our office space in San Jose, California. As a result, we recorded an impairment charge of $9.1 million, which includes $6.8 million associated with the right-of-use asset and $2.3 million associated with the leasehold improvements and furniture, fixtures and equipment included in the San Jose office asset group. Refer to Note 4, Balance Sheet Components , for further information about the impairment of the right-of-use asset and long-lived assets. Separation Expense Separation expense consists primarily of costs of legal and professional services for IPO-related litigation associated with our separation from NETGEAR. The following table presents separation expense for the periods indicated: Three Months Ended Six Months Ended June 27, 2021 % Change June 28, 2020 June 27, 2021 % Change June 28, 2020 (In thousands, except percentage data) Separation expense $ 605 637.8 % $ 82 $ 659 309.3 % $ 161 Gain on sale of business 43 Table of Contents The following table presents gain on sale of business for the periods indicated: Three Months Ended Six Months Ended June 27, 2021 % Change June 28, 2020 June 27, 2021 % Change June 28, 2020 (In thousands, except percentage data) Gain on sale of business $ — ** $ — $ (292) ** $ — **Percentage change not meaningful In the fourth quarter of 2019, we sold our commercial operations in Europe which resulted in a gain on sale of business. In the first quarter of 2020, we recognized an additional gain of $292 thousand as a result of the final working capital adjustment. Interest Income and Other Income (Expense), Net The following table presents other income (expense), net for the periods indicated: Three Months Ended Six Months Ended June 27, 2021 % Change June 28, 2020 June 27, 2021 % Change June 28, 2020 (In thousands, except percentage data) Interest income 3 ** 151 27 ** 686 Other income (expense), net 2,662 ** 1,111 3,571 ** 2,294 **Percentage change not meaningful. Our interest income was primarily earned from our short-term investments and cash and cash equivalents. We expect our interest income in absolute dollars to decrease as we deploy our short-term investments and cash and cash equivalents to fund our operations, while interest rates have also declined. Interest income decreased for the three and six months ended June 27, 2021, compared to the prior year periods, primarily due to the decrease in our short-term investments and cash and cash equivalents as we funded our operations, and a decline in interest rates. Other income (expense), net primarily represents gains and losses on transactions denominated in foreign currencies, foreign currency contract gain (loss), net, and other miscellaneous income and expense. We have also included reimbursements for the Verisure Transition Service Agreement ("TSA") in Other income. Other income (expense), net, increased for the three and six months ended June 27, 2021, compared to the prior year periods, primarily due to the Employee Retention Credit ("ERC") under the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") for qualified wages amounting to $1.8 million, which was recognized as Other income in the second quarter of 2021, partially offset by decreases in Verisure TSA related income. The CARES Act was signed into law on March 27, 2020 in response to the COVID-19 pandemic. The ERC, as one of the provisions that provide economic relief for individuals and businesses under the CARES Act, is a refundable payroll tax credit that encouraged businesses to keep employees on the payroll during the COVID-19 pandemic. Provision for Income Taxes Three Months Ended Six Months Ended June 27, 2021 % Change June 28, 2020 June 27, 2021 % Change June 28, 2020 (In thousands, except percentage data) Provision for income taxes $ 164 (10.4) % $ 183 $ 344 4.9 % $ 328 Effective tax rate (0.7) % (0.6) % (1.0) % (0.5) % 44 Table of Contents The Company’s provision for income taxes was primarily attributable to income taxes on foreign earnings. The provision for income taxes for the three months ended June 27, 2021 was slightly lower than the same period in the prior year primarily due to a decrease in foreign earnings in the second quarter of 2021. The provision for income taxes for the six months ended June 27, 2021, was slightly higher than the same period in the prior year primarily due to an increase in foreign earnings in the first half of 2021. Losses incurred predominantly in the U.S. continue to be subject to a full valuation allowance. Liquidity and Capital Resources We have a history of losses and may continue to incur operating and net losses for the foreseeable future. As of June 27, 2021, our accumulated deficit was $266.8 million. Our principal sources of liquidity are cash, cash equivalents and short-term investments. Short-term investments are marketable government securities with an original maturity or a remaining maturity at the time of purchase of greater than three months and no more than 12 months. The marketable securities are held in our company’s name with a high quality financial institution, which acts as our custodian and investment manager. As of June 27, 2021, we had cash, cash equivalents and short-term investments totaling $178.7 million. 7.8% of our cash and cash equivalents were held outside of the U.S. Starting in 2018, the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) 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. 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 June 27, 2021, we have not borrowed against this credit facility. Refer to Note 8. Debt in the Notes to Unaudited Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q for further details on such business financing agreement. 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. 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 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. Our future liquidity and cash requirements will depend on numerous factors, including the introduction of new products, the growth in our service revenue, as well as the ability to increase our gross margin dollars and continue to maintain controls over our operating expenditures. Cash Flow The following table presents our cash flows for the periods presented: Six Months Ended June 27, 2021 June 28, 2020 (In thousands) Net cash used in operating activities $ (23,466) $ (48,683) Net cash provided by (used in) investing activities 18,934 (1,278) Net cash used in financing activities (2,948) (1,293) Net cash decrease $ (7,480) $ (51,254) 45 Table of Contents Operating activities Net cash used in operating activities decreased by $25.2 million for the six months ended June 27, 2021 compared to the prior year period. This decrease comprised a $41.8 million reduction in adjusted net loss reconciled to net cash used in operating activities, offset by an increase in working capital used in operations of $16.6 million, mainly driven by a reduction in prepaid expenses and other assets. Our days sales outstanding (“DSO”) decreased to 48 days as of June 27, 2021 compared to 64 days as of December 31, 2020, primarily as a result of in-quarter collections from our customers that were on seasonal dating terms and unpaid in the fourth quarter of 2020, as well as a change in customer mix and an increase in service revenue. Typically, our DSO in the fourth quarter is higher due to seasonal payment terms provided to our larger customers. Inventory decreased to $43.2 million as of June 27, 2021 from $64.7 million as of December 31, 2020, as we reduced our product purchases in line with the normal seasonality of our business and continued to focus on effective inventory management. Our ending inventory turns were 5.7x in the three months ended June 27, 2021 up from 5.0x turns in the three months ended December 31, 2020, primarily as a result of effective inventory management. Our accounts payable decreased to $42.9 million as of June 27, 2021 from $62.2 million as of December 31, 2020, primarily as a result of lower inventory purchases and payments to suppliers for the purchases made in the fourth quarter of 2020. Investing activities Net cash provided by investing activities increased by $20.2 million for the six months ended June 27, 2021 compared to the prior year period, primarily due to maturity of our of short-term investments. Financing activities Net cash used in financing activities was $2.9 million for the six months ended June 27, 2021, representing tax withholdings from restricted stock unit releases of $9.1 million, offset by proceeds from ESPP contributions and exercises of stock options of $6.1 million. Net cash used in financing activities was $1.3 million for the six months ended June 28, 2020, representing tax withholdings from restricted stock unit releases of $3.1 million, offset by proceeds from ESPP contributions of $1.9 million. Contractual Obligations Our principal commitments consist of obligations under operating leases for office space, equipment, data center facilities and distribution center facilities, as well as non-cancellable purchase commitments. Refer to Note 9. Commitments and Contingencies, in Notes to Unaudited Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q for a complete discussion of our contractual obligations. Critical Accounting Policies and Estimates For a complete description of what we believe to be the critical accounting policies and estimates used in the preparation of our Unaudited Condensed Consolidated Financial Statements, refer to our Annual Report on Form 10-K for the year ended December 31, 2020. There have been no material changes to our critical accounting policies and estimates during the six months ended June 27, 2021, other than as discussed in Note 2. Significant Accounting Policies and Recent Accounting Pronouncements, in the Notes to Unaudited Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q, 46 Table of Contents 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 and Recent Accounting Pronouncements , in Notes to Unaudited Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q. 47 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk During the six months ended June 27, 2021, there were no material changes to our market risk disclosures as set forth in Part II Item 7A "Quantitative and Qualitative Disclosures About Market Risk" in our Annual Report on Form 10-K for the year ended December 31, 2020.