What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-08-10 compared with 2023-05-11 · 78 added, 65 removed, 166 unchanged (46% of the section changed)

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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.

This Quarterly Report on Form 10-Q (the “Quarterly 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.

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These statements are inherently uncertain and investors are cautioned not to unduly rely upon these 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 on Form 10-Q (the “Quarterly Report”).

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.

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Since the launch of our first product in December 2014, we have shipped over 29.4 million smart connected devices.

As of April 2, 2023, the Arlo platform had approximately 7.5 million cumulative registered accounts across more than 100 countries around the world coupled with 2.0 million cumulative paid subscribers and annual recurring revenue of $182.6 million.

As of July 2, 2023, the Arlo platform had approximately 7.9 million cumulative registered accounts across more than 100 countries around the world coupled with 2.3 million cumulative paid subscribers and annual recurring revenue of $193.6 million.

We conduct business across three geographic regions—(i) the Americas;

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and (iii) 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.

For the three months ended April 2, 2023 and April 3, 2022, we generated total revenue of $111.0 million and $124.8 million, respectively.

Loss from operations was $14.1 million and $8.7 million for the three months ended April 2, 2023 and April 3, 2022, respectively.

For the three months ended July 2, 2023 and July 3, 2022, we generated total revenue of $115.1 million and $119.0 million, respectively.

Loss from operations was $8.0 million and $11.3 million for the three months ended July 2, 2023 and July 3, 2022, respectively.

For the six months ended July 2, 2023 and July 3, 2022, we generated total revenue of $226.1 million and $243.7 million, respectively.

Loss from operations was $22.2 million and $20.0 million for the six months ended July 2, 2023 and July 3, 2022, 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.

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We expect to increase our investment in research and development going forward as we continue to introduce new and innovative products and services to enhance the Arlo platform and compete for engineering talent.

We also expect our sales and marketing expense to increase in the future as we invest in marketing to drive awareness of our brand and demand for our products and services.

We also expect our sales and marketing expense to increase in the future as we invest in marketing to drive demand for our products and services.

Key Business Metrics

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As of and for the Three Months Ended

2023 % Change April 3,

2023 % Change July 3,

(In thousands, except percentage data)

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Cumulative paid accounts (1)

2,289 54.9 % 1,478

Annual recurring revenue $ 193,633 66.1 % $ 116,601

_________________________

(1) The increase for the three months ended July 2, 2023 compared to the prior year period reflects an increase in the number of paid accounts in our EMEA region which were managed by Verisure and now onboarded with us.

This does not have an impact to our financial statements and key business metrics other than our number of Cumulative Paid Accounts.

Cumulative Registered Accounts .

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ARR represents the amount of paid service revenue that we expect to recur annually and is calculated by taking our recurring paid service revenue for the last calendar month in the fiscal quarter, multiplied by 12 months.

Recurring paid service revenue represents the revenue we recognize from our paid accounts and excludes prepaid service revenue and Non-Recurring Engineering (“NRE”) service revenue from strategic partners.

Recurring paid service revenue represents the revenue we recognize from our paid accounts and excludes prepaid service revenue.

ARR is a performance metric and should be viewed independently of revenue and deferred revenue, and is not intended to be a substitute for, or combined with, any of these items.

Impact of Global Geopolitical, Economic and Business Conditions

During the three months ended April 2, 2023, we remained focused on the ongoing conflict in Ukraine, supply chain disruptions, inflation, lower consumer confidence and rising interest rates by preserving our liquidity and managing our cash flow by 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 headcount and non-essential spending, subleasing and not renewing excess office space, and deferring hiring.

We continue to monitor the 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 ongoing conflict in Ukraine, supply chain disruptions, the inflationary macro environment, lower consumer confidence and rising interest rates and current financial conditions within the banking industry, including the effects of recent failures of other financial institutions, and liquidity levels.

During the six months ended July 2, 2023, we remained focused on the ongoing conflict in Ukraine, supply chain disruptions, inflation, fluctuating consumer confidence and rising interest rates by preserving our liquidity and managing our cash flow by 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 subleasing or reducing excess office space.

We continue to monitor the 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 ongoing conflict in Ukraine, supply chain disruptions, the inflationary macro environment, fluctuating consumer confidence and rising interest rates and current financial conditions within the banking industry, including the effects of recent failures of other financial institutions, and liquidity levels.

Results of Operations

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The following table sets forth, for the periods presented, the unaudited condensed consolidated statements of comprehensive loss data, which we derived from the accompanying unaudited condensed consolidated financial statements:

Three Months Ended

2023 April 3,

Three Months Ended Six Months Ended

(In thousands, except percentage data)

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Loss from operations (8,029) (7.0) % (11,342) (9.5) % (22,169) (9.8) % (20,014) (8.2) %

Interest income (expense), net 726 0.7 % (5) — %

Other income, net (39) — % 411 0.3 %

Interest income, net 835 0.8 % 129 0.1 % 1,561 0.7 % 124 0.1 %

Other income (expense), net 52 — % (116) (0.1) % 13 — % 295 0.1 %

Loss before income taxes (7,142) (6.2) % (11,329) (9.5) % (20,595) (9.1) % (19,595) (8.0) %

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Net loss $ (7,363) (6.4) % $ (11,557) (9.7) % $ (21,608) (9.6) % $ (20,036) (8.2) %

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

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

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

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

Our services also include certain development services provided to strategic partners under NRE arrangements.

Our revenue consists of gross revenue, less end-user customer rebates and other channel sales incentives, allowances for estimated sales returns, price protection, and net changes in deferred revenue.

Our revenue consists of gross revenue, less customer rebates and other channel sales incentives, 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.

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and (iii) APAC—and 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

2023 % Change April 3,

Three Months Ended Six Months Ended

2023 % Change July 3,

(In thousands, except percentage data)

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Total revenue $ 115,076 (3.3) % $ 118,979 $ 226,080 (7.2) % $ 243,730

Product revenue decreased in all regions by $27.8 million, or 29.3% for the three months ended April 2, 2023 compared to the prior year period, primarily driven by the decrease in product shipments in all regions due to a reduction in the average selling prices (“ASPs”) of our products as we increased promotional activities to stimulate household acquisition and increased subscriber growth coupled with the softening consumer demand as a result of current macro-economic factors.

Service revenue increased in all regions by $14.0 million, or 46.8% for the three months ended April 2, 2023 compared to the prior year period, primarily due to increases in paid accounts and rates for our subscription plans.

Product revenue decreased by $21.4 million, or 24.9% and $49.2 million, or 27.2% for the three and six months ended July 2, 2023 compared to the prior year periods.

The declines were experienced mainly in EMEA and Americas primarily driven by a reduction in the average selling prices (“ASPs”) of our products as we increased promotional activities to stimulate household acquisition and increased subscriber growth coupled with a shift in product mix driven by the softening consumer demand as a result of current macro-economic factors and seasonality.

Service revenue increased in all regions by $17.5 million, or 53.5% and $31.6 million, or 50.3% for the three and six months ended July 2, 2023 compared to the prior year periods, primarily due to a 54.9% increase in cumulative paid accounts and rates for our subscription plans.

Cost of Revenue

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Product costs primarily consist of the cost of finished products from our third-party manufacturers and overhead costs, including personnel expense for operation staff, 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 and excess components, and royalties to third parties.

Service costs consist of costs attributable to the provision and maintenance of our cloud-based platform, including personnel, storage, security and computing, IT and facilities overhead as well as NRE service costs incurred under NRE arrangements.

Service costs consist of costs attributable to the provision and maintenance of our cloud-based platform, including personnel, storage, security and computing, IT and facilities overhead.

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, 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 costs, and charges for excess or obsolete inventory.

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

Three Months Ended

2023 % Change April 3,

Three Months Ended Six Months Ended

2023 % Change July 3,

(In thousands, except percentage data)

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Total cost of revenue $ 73,218 (14.1) % $ 85,239 $ 149,005 (15.5) % $ 176,415

Product cost of revenue decreased 20.7% for the three months ended April 2, 2023 compared to the prior year period, primarily due to a decrease in product shipments coupled with a decrease in freight-in costs due to normalization of the supply chain and utilization of ocean freight.

Service cost of revenue increased 13.0% for the three months ended April 2, 2023 compared to the prior year period, as a result of service revenue growth, offset by cost optimizations.

Product cost of revenue decreased 18.1% and 19.5% for the three and six months ended July 2, 2023 compared to the prior year periods, respectively, primarily due to decreases in product shipments coupled with decreases in freight-in costs due to normalization of the supply chain and utilization of ocean freight, partially offset by increases in inventory reserves.

Service cost of revenue increased 11.9% and 12.4% for the three and six months ended July 2, 2023 compared to the prior year periods, respectively, as a result of service revenue growth, offset by cost optimizations.

The following table presents gross profit for the periods indicated:

Three Months Ended

2023 % Change April 3,

Three Months Ended Six Months Ended

2023 % Change July 3,

(In thousands, except percentage data)

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Total gross margin 36.4 % 28.4 % 34.1 % 27.6 %

Product gross profit decreased for the three months ended April 2, 2023 compared to the prior year period, primarily due to the decrease in product shipments in all regions due to a reduction in the ASPs of our products as we increased promotional activities to stimulate household acquisition and increased subscriber growth coupled with the softening consumer demand as a result of current macro-economic factors.

Product gross profit decreased for the three and six months ended July 2, 2023 compared to the prior year periods, primarily driven by a reduction in the ASPs of our products as we increased promotional activities to stimulate household acquisition and increased subscriber growth coupled with a shift in product mix driven by the softening consumer demand as a result of current macro-economic factors.

The product gross profit decrease was partially offset by the decrease in freight-in costs due to normalization of the supply chain and utilization of ocean freight.

Service gross profit increased for the three months ended April 2, 2023 compared to the prior year period, primarily due to growth in paid service revenue in all regions as a result of increases in paid accounts and rates for our subscription plans as well as cost optimizations.

Service gross profit increased for the three and six months ended July 2, 2023 compared to the prior year periods, primarily due to growth in paid service revenue in all regions as a result of a 54.9% increase in cumulative paid accounts and rates for our subscription plans as well as cost optimizations.

Operating Expenses

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Generally, we recognize research and development expenses as they are incurred.

Research and development expense directly attributable to delivering the Verisure NRE is recognized in cost of service.

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

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The following table presents research and development expense for the periods indicated:

Three Months Ended

2023 % Change April 3,

Three Months Ended Six Months Ended

2023 % Change July 3,

(In thousands, except percentage data)

Research and development expense $ 17,618 1.2 % $ 17,402 $ 35,368 4.7 % $ 33,781

Research and development expense increased by $1.4 million for the three months ended April 2, 2023 compared to the prior year period, primarily due to an increase of $2.0 million in personnel-related expenses mainly from stock-based compensation and merit increase in base salary, partially offset by a decrease of $0.7 million in corporate IT and facilities overhead.

Research and development expense increased by $0.2 million for the three months ended July 2, 2023 compared to the prior year period, primarily due to an increase of $0.5 million in personnel-related expenses mainly from increase in base compensation as a result of headcount increase, partially offset by a decrease of $0.2 million in corporate IT and facilities overhead.

Research and development expense increased by $1.6 million for the six months ended July 2, 2023 compared to the prior year period, primarily due to an increase of $2.5 million in personnel-related expenses mainly from stock-based compensation and merit increases, partially offset by a decrease of $0.9 million in corporate IT and facilities overhead.

Sales and Marketing

Sales and marketing expense consists primarily of personnel expense for sales and marketing staff, technical support expense, advertising, trade shows, media and placement, 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 increase in the future as we invest in marketing to drive awareness of our brand and demand for our products and services.

We expect our sales and marketing expense to increase in the future as we invest in marketing to drive demand for our products and services.

The following table presents sales and marketing expense for the periods indicated:

Three Months Ended

2023 % Change April 3,

Three Months Ended Six Months Ended

2023 % Change July 3,

(In thousands, except percentage data)

Sales and marketing expense $ 16,921 16.6 % $ 14,506 $ 32,274 16.6 % $ 27,674

Sales and marketing expense increased $2.2 million for the three months ended April 2, 2023 compared to the prior year period, primarily due to increases of $1.0 million in marketing expenditures, $0.6 million in credit card processing fees and $0.4 million freight-out expenses.

Sales and marketing expense increased $2.4 million for the three months ended July 2, 2023 compared to the prior year period, primarily due to increases of $0.7 million in marketing expenditures, $0.7 million in customer care services, $0.7 million freight-out expenses, and $0.6 million in credit card processing fees as a result of increases in Arlo.com Store sales and paid subscriber accounts.

Sales and marketing expense increased $4.6 million for the six months ended July 2, 2023 compared to the prior year period, primarily due to increases of $1.7 million in marketing expenditures, $1.2 million in credit card processing fees as a result of increases in Arlo.com Store sales and paid subscriber accounts, $1.1 million freight-out expenses, and $1.0 million in customer care services.

General and Administrative

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The following table presents general and administrative expense for the periods indicated:

Three Months Ended

2023 % Change April 3,

Three Months Ended Six Months Ended

2023 % Change July 3,

(In thousands, except percentage data)

General and administrative expense $ 15,007 14.1 % $ 13,149 $ 30,629 18.9 % $ 25,770

General and administrative expense increased $3.0 million for the three months ended April 2, 2023 compared to the prior year period, primarily due to an increase of $3.9 million in personnel-related expenses mainly from stock-based compensation and merit increase in base salary, partially offset by decreases of $0.8 million in corporate IT and facilities overhead and other.

General and administrative expense increased $1.9 million for the three months ended July 2, 2023 compared to the prior year period, primarily due to an increase of $2.6 million in personnel-related expenses mainly from stock-based compensation, partially offset by decreases of $0.6 million in legal and professional services and corporate IT and facilities overhead.

General and administrative expense increased $4.9 million for the six months ended July 2, 2023 compared to the prior year period, primarily due to an increase of $6.6 million in personnel-related expenses mainly from stock-based compensation and merit increases, partially offset by decreases of $1.6 million in corporate IT and facilities overhead and legal and professional services.

Others include separation expense, which consists primarily of costs of legal and professional services for IPO-related litigation associated with our separation from NETGEAR, and restructuring charges, which consist of severance costs and office exit expense associated with the abandonment of certain lease contracts.

Interest Income (Expense) and Other Income (Expense), Net

The following table presents interest income (expense) and other income (expense), net for the periods indicated:

Three Months Ended

2023 % Change April 3,

Interest Income and Other Income (Expense), Net

The following table presents interest income and other income (expense), net for the periods indicated:

Three Months Ended Six Months Ended

2023 % Change July 3,

(In thousands, except percentage data)

Interest income (expense), net $ 726 ** $ (5)

Interest income, net $ 835 ** $ 129 1,561 ** 124

Other income (expense), net $ 52 ** $ (116) 13 (95.6) % 295

**Percentage change not meaningful.

Interest income (expense), net increased for the three months ended April 2, 2023 compared to the prior year period, primarily due to the increase in our short-term investments as well as a result of higher interest rates.

Other income (expense), net decreased for the three months ended April 2, 2023 compared to the prior year period, primarily due to the foreign currency exchange losses for the three months ended April 2, 2023 compared to the foreign currency exchange gains in the prior year period.

Interest income, net increased for the three and six months ended July 2, 2023 compared to the prior year periods, primarily due to the increase in our short-term investments as well as a result of higher interest rates.

Provision for Income Taxes

The following table presents provision for income taxes for the periods indicated:

Three Months Ended

2023 % Change April 3,

Three Months Ended Six Months Ended

2023 % Change July 3,

(In thousands, except percentage data)

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Effective tax rate (3.1) % (2.0) % (4.9) % (2.3) %

Provision for income taxes increased for the three months ended April 2, 2023, compared to the prior year period, primarily due to higher U.S.

earnings and also the application of Section 174 of the Internal Revenue Code requiring capitalization of research and experimental expenses.

Consistent with the prior year, we maintained a valuation allowance against our U.S.

Provision for income taxes decreased slightly for the three months ended July 2, 2023, compared to the prior year period and increased for the six months ended July 2, 2023, compared to the prior year period, primarily due to the higher U.S.

earnings and also the application of Section 174 of the Internal Revenue Code requiring capitalization of research and experimental expenses, which increase was recognized mostly in the first quarter of 2023.

Consistent with the prior year periods, we maintained a valuation allowance against our U.S.

federal and state deferred tax assets and did not record a tax benefit on these deferred tax assets since it is more likely than not that these deferred tax assets will not be realized.

Liquidity and Capital Resources

As of April 2, 2023, our cash and cash equivalent and short-term investments totaled $118.7 million and we had unused borrowing capacity of $8.4 million based on the terms and conditions of our revolving credit facility.

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

As of April 2, 2023, our accumulated deficit was $359.7 million.

As of July 2, 2023, our cash and cash equivalents and short-term investments totaled $123.7 million and we had unused borrowing capacity of $13.8 million based on the terms and conditions of our revolving credit facility.

We have a history of losses and may incur operating and net losses in the future.

As of July 2, 2023, our accumulated deficit was $367.0 million.

Historically, we have funded our principal business activities through cash flows generated from operations and available cash on hand.

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Refer to Note 8.

Commitments and Contingencies 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 information about our operating leases, purchase obligations, and legal contingencies.

Commitments and Contingencies in the Notes to Unaudited Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report for further information about our operating leases, purchase obligations, and legal contingencies.

The following table presents our cash flows for the periods presented:

Three Months Ended

2023 April 3,

Six Months Ended

(In thousands)

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Operating activities

Net cash provided by operating activities increased by $34.9 million for the three months ended April 2, 2023 compared to the prior year period, primarily due to changes in working capital as a result of an increase in our service revenue driven by growth in paid accounts and increased subscription rates, higher collection from customers on products sales due to enhanced collection efforts, and lower payments to suppliers primarily as a result of lower inventory purchases.

Net cash provided by operating activities increased by $52.3 million for the six months ended July 2, 2023 compared to the prior year period, primarily due to improved profitability and changes in working capital as a result of an increase in our service revenue driven by growth in paid accounts and increased subscription rates, lower payments to suppliers primarily as a result of reduced inventory purchases, and higher collection from customers on products sales due to enhanced collection efforts.

Investing activities

Net cash used in investing activities decreased by $22.3 million for the three months ended April 2, 2023 compared to the prior year period, primarily due to lower net purchases of short-term investments.

Net cash used in investing activities decreased by $17.3 million for the six months ended July 2, 2023 compared to the prior year period, primarily due to a decrease in net purchases, and maturities, of short-term investments.

Financing activities

Net cash used in financing activities decreased by $0.6 million for the three months ended April 2, 2023 compared to the prior year period, primarily due to the decrease in withholding tax from restricted stock unit releases, partially offset by lower proceeds related to employee benefit plans.

Net cash used in financing activities increased by $1.6 million for the six months ended July 2, 2023 compared to the prior year period, primarily due to the increase in withholding tax from restricted stock unit releases, partially offset by higher proceeds related to employee benefit plans.

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, 2022.

There have been no material changes to our critical accounting policies and estimates during the three months ended April 2, 2023, other than as discussed in Note 2.

There have been no material changes to our critical accounting policies and estimates during the six months ended July 2, 2023, 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.

Quantitative and Qualitative Disclosures About Market Risk

During the three months ended April 2, 2023, 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, 2022.

During the six months ended July 2, 2023, 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, 2022.

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-Q

Item 2. Management’s Discussion and Analysis