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Item 1A. Risk Factors

2022-03-02 compared with 2021-02-26 · 293 added, 229 removed, 605 unchanged (46% of the section changed)

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Risks Related to Our Business

The effects of health epidemics, including the recent COVID-19 pandemic, could have an adverse impact on our business, operations and the markets and communities in which we, our partners and customers operate.

The effects of health epidemics, including the COVID-19 pandemic and its variants, could have an adverse impact on our business, operations and the markets and communities in which we, our partners and customers operate.

Our business and operations could be adversely affected by health epidemics, including the recent COVID-19 pandemic, impacting the markets and communities in which we, our partners and our customers operate.

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

The President of the United States has declared the COVID-19 pandemic a national emergency.

In response to the COVID-19 pandemic, many state, local and foreign governments have put in place, and others in the future may put in place, quarantines, executive orders, shelter-in-place orders and similar government orders and restrictions in order to control the spread of the disease.

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For example, we have implemented a work-from-home policy for the vast majority of employees, and we may take further actions that alter our operations as may be required by federal, state or local authorities, or which we determine are in the best interests of our employees, customers, partners and stockholders.

The effects of pandemic adversely affected our product shipments and financial results for the year ended December 31, 2020.

In addition, while the potential impact and duration of the COVID-19 pandemic on the global economy and our business in particular may be difficult to assess or predict, the pandemic has resulted in, and may continue to result in significant disruption of global financial markets, reducing our ability to access capital, which could in the future negatively affect our liquidity.

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In addition, a recession or market correction resulting from the spread of COVID-19 could further decrease technology spending, adversely affecting demand for our products and services, our business and the value of our common stock.

As of December 31, 2020, our retail channel inventory in Americas declined compared to December 31, 2019 due to disruption to our sales channel, contributing to a decline in net revenue in Americas by 6.8%, compared to the year ended December 31, 2019.

The COVID-19 pandemic may adversely affect the ability of our third-party manufacturers and other suppliers to fulfill their obligations to us.

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In addition, if we are unable to meet customer demand due to fluctuating or late supply from our third-party manufacturers and other suppliers, it could result in lost sales and have a material adverse effect on our business.

We also rely on other suppliers such as cloud infrastructure services

providers, distribution centers and logistics and transportation services providers.

We also rely on other suppliers such as cloud infrastructure services providers, distribution centers and logistics and transportation services providers.

If our manufacturers and other suppliers are unable to fulfill their obligations to us, we could face products shortages, delay in new product introductions, services to our customers could be interrupted, and our products distribution could be delayed and thus adversely affecting our revenue.

For the year ended December 31, 2020, our freight-in expense increased by 56%, compared to the prior year.

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 December 31, 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 year ended December 31, 2021, we saw a 138% increase in freight-in expense compared to the prior year, 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 continue in 2022.

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.

The global pandemic of COVID-19 continues to rapidly evolve, and we will continue to monitor the COVID-19 situation closely.

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We do not yet know the full extent of potential delays or impacts on our business, operations or the global economy as a whole.

We obtain several key components from limited or sole sources, and if these sources fail to satisfy our supply requirements or we are unable to properly manage our supply requirements with our third-party manufacturers, we may lose sales and experience increased component costs.

Any shortage or delay in the supply of key product components would harm our ability to meet scheduled product deliveries.

Many of the components used in our products are specifically designed for use in our products, some of which are obtained from sole source suppliers.

These components include lens, lens-sensors, and passive infrared (“PIR”) sensors that have been customized for the Arlo application, as well as custom-made batteries that provide power conservation and safety features.

In addition, the components used in our end products have been optimized to extend battery life.

Our third-party manufacturers generally purchase these components on our behalf, and we do not have any contractual commitments or guaranteed supply arrangements with our suppliers.

If demand for a specific component increases, we may not be able to obtain an adequate number of that component in a timely manner.

In addition, if worldwide demand for the components increases significantly, the availability of these components could be limited.

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 and throughout 2021 we experienced component shortages, including longer lead times for components, and supply constraints, which we expect to continue in 2022.

Such shortages and constraints affected our ability to meet scheduled product deliveries and worldwide demand for our products in 2021, and may affect our ability in 2022.

Further, our suppliers may experience financial or other difficulties as a result of uncertain and weak worldwide economic conditions.

Other factors that may affect our suppliers’ ability or willingness to supply components to us include internal management or reorganizational issues, such as roll-out of new equipment which may delay or disrupt supply of previously forecasted components, or industry consolidation and divestitures, which may result in changed business and product priorities among certain suppliers.

It could be difficult, costly, and time consuming to obtain alternative sources for these components, or to change product designs to make use of alternative components.

In addition, difficulties in transitioning from an existing supplier to a new supplier could create delays in component availability that would have a significant impact on our ability to fulfill orders for our products.

We provide our third-party manufacturers with a rolling forecast of demand, which they use to determine our material and component requirements.

Lead times for ordering materials and components vary significantly and depend on various factors, such as the specific supplier, contract terms, and demand and supply for a component at a given time.

Some of our components have long lead times, such as wireless local area network chipsets, physical layer transceivers, connector jacks, and metal and plastic enclosures.

If our forecasts are not timely provided or are less than our actual requirements, our third-party manufacturers may be unable to manufacture products in a timely manner.

If our forecasts are too high, our third-party manufacturers will be unable to use the components they have purchased on our behalf.

of the components used in our products tends to drop rapidly as volumes increase and the technologies mature.

Therefore, if our third-party manufacturers are unable to promptly use components purchased on our behalf, our cost of producing products may be higher than our competitors due to an oversupply of higher-priced components.

Moreover, if they are unable to use components ordered at our direction, we will need to reimburse them for any losses they incur.

If we are unable to obtain a sufficient supply of components, or if we experience any interruption in the supply of components, our product shipments could be reduced or delayed or our cost of obtaining these components may increase.

For example, in December 2018 we announced a delay in the expected timing of shipment of our Ultra product due to a battery-related issue from one of our suppliers.

Component shortages and delays affect our ability to meet scheduled product deliveries, damage our brand and reputation in the market, and cause us to lose sales and market share.

For example, component shortages and disruptions in supply in the past have limited our ability to supply all the worldwide demand for our products, and our revenue was affected.

At times, we have elected to use more expensive transportation methods, such as air freight, to make up for manufacturing delays caused by component shortages, which reduces our margins.

In addition, at times sole suppliers of highly specialized components have provided components that were either defective or did not meet the criteria required by our retailers, distributors, or other channel partners, resulting in delays, lost revenue opportunities, and potentially substantial write-offs.

We depend on a limited number of third-party manufacturers for substantially all of our manufacturing needs.

If these third-party manufacturers experience any delay, disruption, or quality control problems in their operations, including due to the COVID-19 pandemic, we could lose market share and our brand may suffer.

All of our products are manufactured, assembled, tested and generally packaged by a limited number of third-party original design manufacturers (“ODMs”).

In most cases, we rely on these manufacturers to procure components and, in some cases, subcontract engineering work.

We currently outsource manufacturing to Foxconn Cloud Network Technology Singapore Pte.

Ltd., Pegatron Corporation, and Wistron NeWeb Corporation.

We do not have any long-term contracts with any of these third-party manufacturers, although we have executed product supply agreements with these manufacturers, which typically provide indemnification for intellectual property infringement, epidemic failure clauses, agreed-upon price concessions, and certain product quality requirements.

Some of these third-party manufacturers produce products for our competitors.

In addition, one of our principal manufacturers, Foxconn closed its acquisition of Belkin International in September 2018, which includes the WeMo brand of home automation products, which may compete directly with us.

Due to changing economic conditions, including due to the COVID-19 pandemic, the viability of some of these third-party manufacturers may be at risk.

The loss of the services of any of our primary third-party manufacturers could cause a significant disruption in operations and delays in product shipments.

Qualifying a new manufacturer and commencing volume production is expensive and time consuming.

Ensuring that a contract manufacturer is qualified to manufacture our products to our standards is time consuming.

In addition, there is no assurance that a contract manufacturer can scale its production of our products at the volumes and in the quality that we require.

If a contract manufacturer is unable to do these things, we may have to move production for the products to a new or existing third-party manufacturer, which would take significant effort and our business, results of operations, and financial condition could be materially adversely affected.

In addition, as we contemplate moving manufacturing into different jurisdictions, we may be subject to additional significant challenges in ensuring that quality, processes, and costs, among other issues, are consistent with our expectations.

For example, while we expect our manufacturers to be responsible for penalties assessed on us because of excessive failures of the products, there is no assurance that we will be able to collect such reimbursements from these manufacturers, which causes us to take on additional risk for potential failures of our products.

Our reliance on third-party manufacturers also exposes us to the following risks over which we have limited control:

• unexpected increases in manufacturing and repair costs;

• inability to control the quality and reliability of finished products;

• inability to control delivery schedules;

• potential liability for expenses incurred by third-party manufacturers in reliance on our forecasts that later prove to be inaccurate;

• potential lack of adequate capacity to manufacture all or a part of the products we require;

• potential labor unrest affecting the ability of the third-party manufacturers to produce our products.

All of our products must satisfy safety and regulatory standards and some of our products must also receive government certifications.

Our third-party manufacturers are primarily responsible for conducting the tests that support our applications for most regulatory approvals for our products.

If our third-party manufacturers fail to timely and accurately conduct these tests, we would be unable to obtain the necessary domestic or foreign regulatory approvals or certificates to sell our products in certain jurisdictions.

As a result, we would be unable to sell our products and our sales and profitability could be reduced, our relationships with our sales channel could be harmed, and our reputation and brand would suffer.

Specifically, substantially all of our manufacturing and assembly occurs in the Asia Pacific region, primarily in Vietnam, and any disruptions due to natural disasters, health epidemics, and political, social, and economic instability in the region would affect the ability of our third-party manufacturers to manufacture our products.

In particular, in the event the labor market in Vietnam becomes saturated, our third-party manufacturers in Vietnam may increase our costs of production.

If these costs increase, it may affect our margins and ability to lower prices for our products to stay competitive.

Labor unrest may also affect our third-party manufacturers, as workers may strike and cause production delays.

If our third-party manufacturers fail to maintain good relations with their employees or contractors, and production and manufacturing of our products are affected, then we may be subject to shortages of products and the quality of products delivered may be affected.

Further, if our manufacturers or warehousing facilities are disrupted or destroyed, we could have no other readily available alternatives for manufacturing and assembling our products, and our business, results of operations, and financial condition could be materially adversely affected.

In the future, we may work with more third-party manufacturers on a contract manufacturing basis, which could result in our exposure to additional risks not inherent in a typical ODM arrangement.

Such risks may include our inability to properly source and qualify components for the products, lack of software expertise resulting in increased software defects, and lack of resources to properly monitor the manufacturing process.

In our typical ODM arrangement, our ODMs are generally responsible for sourcing the components of the products and warranting that the products will work according to a product’s specification, including any software specifications.

In a contract manufacturing arrangement, we would take on much more, if not all, of the responsibility around these areas.

If we are unable to properly manage these risks, our products may be more susceptible to defects, and our business, results of operations, and financial condition could be materially adversely affected.

If disruptions in our transportation network occur or our shipping costs substantially increase, including due to the COVID-19 pandemic, we may be unable to sell or timely deliver our products, and our operating expenses could increase.

We are highly dependent upon the transportation systems we use to ship our products, including surface, ocean and air freight.

Our attempts to closely match our inventory levels to our product demand intensify the need for our transportation systems to function effectively and without delay.

On a quarterly basis, our shipping volume also tends to steadily increase as the quarter progresses, which means that any disruption in our transportation network in the latter half of a quarter will likely have a more material effect on our business than a disruption at the beginning of a quarter.

The transportation network is subject to disruption or congestion from a variety of causes, including labor disputes or port strikes, international conflicts, such as the potential escalating conflict between Russia and Ukraine, acts of war or terrorism, natural disasters, and congestion resulting from higher shipping volumes.

Labor disputes among freight carriers and at ports of entry are common, particularly in Europe, and we expect labor unrest and its effects on shipping our products to be a continuing challenge for us.

A port worker strike, work slow-down, or other transportation disruption in

Long Beach, California, where we import our products to fulfill our American orders, could significantly disrupt our business.

Our international freight is regularly subject to inspection by governmental entities.

As a result of the COVID-19 pandemic, international freight capacity has dropped, causing air and ocean freight rates to materially increase.

Transit times have also increased.

If our delivery times increase unexpectedly for these or any other reasons, our ability to deliver products on time would be materially adversely affected and result in delayed or lost revenue as well as customer imposed penalties.

In addition, if increases in fuel prices occur, our transportation costs would likely increase.

Moreover, the cost of shipping our products by air freight is greater than by other methods.

From time to time in the past and increasingly more common during the COVID-19 pandemic, we have shipped products using extensive air freight to meet unexpected spikes in demand and shifts in demand between product categories, to bring new product introductions to market quickly and to timely ship products previously ordered.

If we continue to rely more heavily upon air freight to deliver our products, our overall shipping costs will increase.

A prolonged transportation disruption or a significant increase in the cost of freight could materially adversely affect our business, results of operations, and financial condition.

If we lose the services of key personnel, we may not be able to execute our business strategy effectively.

Our future success depends in large part upon the continued services of our key technical, engineering, sales, marketing, finance, and senior management personnel.

The competition for qualified personnel with significant experience in the design, development, manufacturing, marketing, and sales in the markets in which we operate is intense, both where our U.S.

operations are based, including Silicon Valley, and in global markets in which we operate.

Our inability to attract qualified personnel, including hardware and software engineers and sales and marketing personnel, could delay the development and introduction of, and harm our ability to sell, our products and services.

Decreases in our stock price may negatively affect our efforts to attract and retain qualified personnel.

Changes to U.S.

immigration policies that restrict our ability to attract and retain technical personnel may negatively affect our research and development efforts.

We will continue to replace key personnel, from within or looking outside, wherever we find the best candidates.

We do not maintain any key person life insurance policies.

Our business model requires extremely skilled and experienced senior management who are able to withstand the rigorous requirements and expectations of our business.

Our success depends on senior management being able to execute at a very high level.

The loss of any of our senior management or other key engineering, research, development, sales, or marketing personnel, particularly if lost to competitors, could harm our ability to implement our business strategy and respond to the rapidly changing needs of our business.

If we suffer the loss of services of any key executive or key personnel, our business, results of operations, and financial condition could be materially adversely affected.

In addition, we may not be able to have the proper personnel in place to effectively execute our long-term business strategy if key personnel retire, resign or are otherwise terminated.

We expect our results of operations to fluctuate on a quarterly and annual basis, which could cause our stock price to fluctuate or decline.

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In order to differentiate our products and services from our competitors’ products, we must continue to increase our focus and capital investment in research and development, including software development.

We have committed a substantial amount of resources to the manufacture, development and sale of our Arlo Smart services and our wire-free smart Wi-Fi cameras, advanced baby monitors, and smart lights, and to introducing additional and improved models in these lines.

We have committed a substantial amount of resources to the manufacture, development and sale of our Arlo Secure services and our wire-free smart Wi-Fi cameras, advanced baby monitors, and smart lights, and to introducing additional and improved models in

In addition, we plan to continue to introduce new categories of smart connected devices to the Arlo platform in the near future.

If our existing products and services do not continue, or if our new products or services fail, to achieve widespread market acceptance, if existing customers do not subscribe to our paid subscription services such as Arlo Smart, if those services do not achieve widespread market acceptance, or if we are unsuccessful in capitalizing on opportunities in the connected lifestyle market, as well as in the related market in the small business segment, our future growth may be slowed and our business, results of operations, and financial condition could be materially adversely affected.

If our existing products and services do not continue, or if our new products or services fail, to achieve widespread market acceptance, if existing customers do not subscribe to our paid subscription services such as Arlo Secure, if those services do not achieve widespread market acceptance, or if we are unsuccessful in capitalizing on opportunities in the connected lifestyle market, as well as in the related market in the small business segment, our future growth may be slowed and our business, results of operations, and financial condition could be materially adversely affected.

Successfully predicting demand trends is difficult, and it is very difficult to predict the effect that introducing a new product or service will have on existing product or service sales.

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If we are unable to generate a high number of positive reviews or quickly respond to negative reviews, including end-user reviews posted on various prominent online retailers, our ability to sell our products and services will be harmed.

Any future delays in product and service development and introduction, or

product and service introductions that do not meet broad market acceptance, or unsuccessful launches of new product and service lines could result in:

Any future delays in product and service development and introduction, or product and service introductions that do not meet broad market acceptance, or unsuccessful launches of new product and service lines could result in:

• loss of or delay in revenue and loss of market share;

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• increased levels of product returns.

Throughout the past few years, Arlo has significantly increased the rate of new product and service introductions, with the introduction of new lines of Arlo cameras, smart lights, and doorbell products, as well as the introduction of our Arlo Smart services.

If we cannot sustain that pace of product and service introductions, either through rapid innovation or acquisition of new products and services or product and service lines, we may not be able to maintain or increase the market share of our products and services or expand further into the connected lifestyle market in accordance with our current plans.

In addition, if we are unable to successfully introduce or acquire new products and services with higher gross margin, our revenue and overall gross margin would likely decline.