Arlo Technologies, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-looking Statements 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. 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, and market position of our products and technology. 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, such information may be limited or incomplete, and we assume no obligation to update any such forward-looking statements. 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. 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 is transforming the ways in which people can protect everything that matters to them with advanced home, business, and personal security services that combine a globally scaled cloud platform, advanced monitoring and analytics capabilities, and award-winning app-controlled devices to create a personalized security ecosystem. Arlo’s deep expertise in cloud services, cutting-edge AI and computer vision analytics, wireless connectivity and intuitive user experience design delivers seamless, smart home security for Arlo users that is easy to setup and engage with every day. Our highly secure, 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 – all rooted in a commitment to safeguard privacy for our users and their personal data. Since the launch of our first product in December 2014, we have shipped over 33.4 million smart connected devices. As of March 31, 2024, the Arlo platform had approximately 9.2 million cumulative registered accounts across more than 100 countries around the world coupled with 3.2 million cumulative paid subscribers and annual recurring revenue of $227.0 million. We conduct business across three geographic regions—(i) the Americas; (ii) Europe, Middle-East and Africa (“EMEA”); 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 March 31, 2024 and April 2, 2023, we generated total revenue of $124.2 million and $111.0 million, respectively. Loss from operations was $10.6 million and $14.1 million for the three months ended March 31, 2024 and April 2, 2023, respectively. Our goal is to continue to develop innovative, world-class smart security 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 channel partnerships and to continue our global expansion. We expect to increase our investment in research and development going forward as we continue to introduce new and 22 Table of Contents 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 demand for our products and services. 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 March 31, 2024 % Change April 2, 2023 (In thousands, except percentage data) Cumulative registered accounts 9,173 22.1 % 7,510 Cumulative paid accounts (1) 3,235 58.3 % 2,044 Annual recurring revenue (“ARR”) (2) $ 226,968 24.3 % $ 182,583 _________________________ (1) The number of cumulative paid accounts as of March 31, 2024 included paid accounts managed by Verisure Sàrl (“Verisure”) in our EMEA region which are 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. (2) As described further below, in the first fiscal quarter of 2024, we changed the methodology on paid service revenue recognition from a mid-month convention to a daily recognition model. As a result, ARR as of March 31, 2024 was calculated using the daily recognition model while ARR as of April 2, 2023 was calculated using our former methodology, the mid-month convention. ARR as of April 2, 2023 calculated using the daily recognition model does not represent a material change from the mid-month convention over the same period. 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 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 end-users to monitor the devices attached to that household. Cumulative Paid Accounts . Paid accounts are defined as any account worldwide where a subscription to a paid service is being collected (either by us or by our customers or channel partners, including Verisure). Annual Recurring Revenue . We believe ARR enables measurement of our business initiatives and serves as an indicator of our future growth. ARR represents the amount of paid service revenue that we expect to recur annually. In the first fiscal quarter of 2024, we changed the methodology on paid service revenue recognition from a mid-month convention to a daily recognition model which recognizes paid service revenue based on the number of service days within the fiscal reporting period, commencing on the start date of the subscription and continuing over the term of the arrangement. Accordingly, the methodology used to calculate ARR was also changed as of March 31, 2024 and is now calculated by taking the average daily paid service revenue of the last calendar month in the fiscal quarter, multiplied by 365 days. We believe the daily recognition model aligns with our customers’ subscription period and service usage and allows for a more precise measurement of paid service revenue relative to the former methodology of a mid-month convention, which was based on paid service revenue for the last calendar month in the fiscal quarter, multiplied by 12 months. This change in calculation methodology has no material impact on our financial statements or any previously reported ARR numbers. 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. 23 Table of Contents Impact of Global Geopolitical, Economic and Business Conditions During the three months ended March 31, 2024, we remained focused on the ongoing conflict in Ukraine, hostilities in the Middle-East, supply chain disruptions, the inflationary macro environment, 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, hostilities in the Middle-East, supply chain disruptions, the inflationary macro environment, fluctuating consumer confidence and rising interest rates, current financial conditions within the banking industry, including the effects of recent failures of other financial institutions, and liquidity levels. 24 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 comprehensive loss data, which we derived from the accompanying unaudited condensed consolidated financial statements: Three Months Ended March 31, 2024 April 2, 2023 (In thousands, except percentage data) Revenue: Products $ 67,493 54.3 % $ 67,060 60.4 % Services 56,707 45.7 % 43,944 39.6 % Total revenue 124,200 100.0 % 111,004 100.0 % Cost of revenue: Products 63,224 50.9 % 64,041 57.7 % Services 13,596 10.9 % 11,746 10.6 % Total cost of revenue 76,820 61.9 % 75,787 68.3 % Gross profit 47,380 38.1 % 35,217 31.7 % Operating expenses: Research and development 20,793 16.7 % 17,750 16.0 % Sales and marketing 17,370 14.0 % 15,353 13.8 % General and administrative 19,348 15.6 % 15,622 14.1 % Others 479 0.3 % 632 0.6 % Total operating expenses 57,990 46.6 % 49,357 44.5 % Loss from operations (10,610) (8.5) % (14,140) (12.8) % Interest income, net 1,386 1.1 % 726 0.7 % Other income, net (25) — % (39) 0.0 % Loss before income taxes (9,249) (7.4) % (13,453) (12.1) % Provision for income taxes 395 0.3 % 792 0.7 % Net loss $ (9,644) (7.7) % $ (14,245) (12.8) % Revenue Our gross revenue consists primarily of sales of devices and 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. Our paid subscription services relate to sales of subscription plans to our registered accounts. 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. 25 Table of Contents We conduct business across three geographic regions—(i) the Americas; (ii) EMEA; and (iii) APAC—and generally base revenue by geographic region on the bill-to location of the customer. Three Months Ended March 31, 2024 % Change April 2, 2023 (In thousands, except percentage data) Americas $ 57,169 0.9 % $ 56,632 Percentage of revenue 46.0 % 51.0 % EMEA 61,380 26.6 % 48,472 Percentage of revenue 49.4 % 43.7 % APAC 5,651 (4.2) % 5,900 Percentage of revenue 4.6 % 5.3 % Total revenue $ 124,200 11.9 % $ 111,004 Revenue by classification is as follows: Three Months Ended March 31, 2024 % Change April 2, 2023 (In thousands, except percentage data) Product revenue $ 67,493 0.6 % $ 67,060 Service revenue 56,707 29.0 % 43,944 Total revenue $ 124,200 11.9 % $ 111,004 Product revenue increased by $0.4 million, or 0.6% for the three months ended March 31, 2024 compared to the prior year period, primarily driven by an increase in product shipments in EMEA due to stronger customer demand, partially offset by the decrease in product sales in the Americas and APAC due to seasonality. The increase in product revenue was partially offset by higher sales incentives that are deemed to be a reduction of revenue. Service revenue increased in all regions by $12.8 million, or 29.0% for the three months ended March 31, 2024 compared to the prior year period, primarily due to a 58.3% increase in cumulative paid accounts and an approximated 30% increase in rates for our subscription plans. Cost of Revenue Cost of revenue consists of both product costs and service costs. 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. 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. We outsource our manufacturing, warehousing, and distribution logistics. We also outsource certain components of the required 26 Table of Contents infrastructure to support our cloud-based back-end IT infrastructure. We believe this outsourcing strategy allows us to better manage our product and service costs and gross margin and allows us to adapt to changing market dynamics and supply chain constraints. Three Months Ended March 31, 2024 % Change April 2, 2023 (In thousands, except percentage data) Cost of revenue: Products $ 63,224 (1.3) % $ 64,041 Services 13,596 15.8 % 11,746 Total cost of revenue $ 76,820 1.4 % $ 75,787 Product cost of revenue decreased 1.3% for the three months ended March 31, 2024 compared to the prior year period, primarily due to a decrease in product warranty reserves, partially offset by an increase in inventory reserves. Service cost of revenue increased 15.8% for the three months ended March 31, 2024 compared to the prior year period, primarily due to service revenue growth as a result of the increase in cumulative paid accounts, partially offset by cost optimizations. Gross Profit Three Months Ended March 31, 2024 % Change April 2, 2023 (In thousands, except percentage data) Gross profit: Products $ 4,269 41.4 % $ 3,019 Services 43,111 33.9 % 32,198 Total gross profit $ 47,380 34.5 % $ 35,217 Gross margin percentage: Products 6.3 % 4.5 % Services 76.0 % 73.3 % Total gross margin 38.1 % 31.7 % Product gross profit increased for the three months ended March 31, 2024 compared to the prior year period, primarily driven by increased product sales in EMEA, partially offset by higher sales incentives that are deemed to be a reduction of revenue. Service gross profit increased for the three months ended March 31, 2024 compared to the prior year period, primarily due to service revenue growth in all regions as a result of increases in cumulative paid accounts and rates for our subscription plans, as well as cost optimizations. 27 Table of Contents Operating Expenses Research and Development Research and development expense consists primarily of personnel-related expense, safety, security, regulatory services and testing, other research and development consulting fees, and allocated IT and facilities overhead. Generally, we recognize research and development expenses as they are incurred. We have invested in and expanded our research and development organization to enhance our ability to introduce innovative products and services. We expect research and development expense to increase in absolute dollars as we develop new product and service offerings and compete for engineering talent. 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. Three Months Ended March 31, 2024 % Change April 2, 2023 (In thousands, except percentage data) Research and development expense $ 20,793 17.1 % $ 17,750 Research and development expense increased by $3.0 million for the three months ended March 31, 2024 compared to the prior year period, primarily due to an increase of $2.1 million in personnel-related expenses mainly from merit increases and stock-based compensation. 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, allocated 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 demand for our products and services. Three Months Ended March 31, 2024 % Change April 2, 2023 (In thousands, except percentage data) Sales and marketing expense $ 17,370 13.1 % $ 15,353 Sales and marketing expense increased $2.0 million for the three months ended March 31, 2024 compared to the prior year period, primarily due to increases of $1.0 million in professional services as a result of continued investment in customer experience improvements across customer care and engineering, $0.9 million in personnel-related expenses mainly from stock-based compensation and merit increases, and $0.2 million credit card processing fees as a result of increases in Arlo.com store sales and paid subscriber accounts. 28 Table of Contents General and Administrative General and administrative expense consists primarily of personnel-related expense for certain executives, finance and accounting, investor relations, human resources, legal, information technology, professional fees, allocated IT and facilities overhead, strategic initiative expense, and other general corporate expense. We expect our general and administrative expense to fluctuate as a percentage of our revenue in future periods based on fluctuations in our revenue and the timing of such expense. Three Months Ended March 31, 2024 % Change April 2, 2023 (In thousands, except percentage data) General and administrative expense $ 19,348 23.9 % $ 15,622 General and administrative expense increased $3.7 million for the three months ended March 31, 2024 compared to the prior year period, primarily due to increases of $2.8 million in personnel-related expenses mainly from stock-based compensation and $0.8 million in professional services. Others Others include separation expense, which consists primarily of costs of legal and professional services and restructuring charges, which consist of severance costs, office exit expense, and other exit expense associated with the abandonment of certain lease contracts and cancellation of contractual services arrangements with certain suppliers. Interest Income, Net and Other Loss, Net Three Months Ended March 31, 2024 % Change April 2, 2023 (In thousands, except percentage data) Interest income, net $ 1,386 90.9 % $ 726 Other loss, net $ (25) ** $ (39) **Percentage change not meaningful. Interest income, net increased for the three months ended March 31, 2024 compared to the prior year period, primarily due to the increase in our short-term investments as well as higher interest rates. Provision for Income Taxes Three Months Ended March 31, 2024 % Change April 2, 2023 (In thousands, except percentage data) Provision for income taxes $ 395 (50.1) % $ 792 Effective tax rate (4.3) % (5.9) % The effective tax rate for the three months ended March 31, 2024 was lower than the U.S. federal income tax rate due to a lower effective tax rate on foreign earnings and valuation allowance on our net U.S. deferred tax assets and certain foreign tax attributes as it is more likely than not that some or all of our deferred tax assets will not be realized. 29 Table of Contents Liquidity and Capital Resources As of March 31, 2024, our cash and cash equivalents and short-term investments totaled $142.9 million and we had unused borrowing capacity of $4.2 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 March 31, 2024, our accumulated deficit was $377.1 million. Historically, we have funded our principal business activities through cash flows generated from operations and available cash on hand. Material Cash Requirements We believe that our existing sources of liquidity will be sufficient to meet our anticipated cash requirements for at least the next 12 months and beyond. However, in the future we may require or desire additional funds to support our operating expenses and capital requirements. To the extent that current and anticipated future sources of liquidity are insufficient, we may seek to raise additional funds through public or private equity. We have no commitments to obtain such additional financing and cannot provide assurance 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 may vary from those currently planned and will depend on numerous factors, including the introduction of new products, the growth in our service revenue, the ability to increase our gross margin dollars, as well as cost optimization initiatives and controls over our operating expenditures. As we grow our installed base and related cost structure, there will be a need for additional working capital, hence, we have increased our subscription rates effective February 3, 2023. Leases and Contractual Commitments Our operating lease obligations mostly include offices, equipment, and distribution centers. Our contractual commitments are primarily inventory-related purchase obligations with suppliers. Contingencies We are involved in disputes, litigation, and other legal actions. We evaluate whether or not a potential loss amount or a potential range of loss is probable and reasonably estimable under the provisions of the authoritative guidance that addresses accounting for contingencies. Significant judgment is required to determine both the probability and the estimated amount of loss. In such cases, we accrue for the amount or, if a range, we accrue the low end of the range, only if there is not a better estimate than any other amount within the range, as a component of legal expense within litigation reserves, net. 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 for further information about our operating leases, purchase obligations, and legal contingencies. Cash Flow Three Months Ended March 31, 2024 April 2, 2023 (In thousands) Net cash provided by operating activities $ 19,806 $ 10,329 Net cash used in investing activities (440) (22,672) Net cash used in financing activities (13,782) (4,691) Net cash increase (decrease) $ 5,584 $ (17,034) 30 Table of Contents Operating activities Net cash provided by operating activities increased by $9.5 million for the three months ended March 31, 2024 compared to the prior year period, primarily due to improved profitability and favorable working capital movements as a result of higher accounts payable balances due to the timing of payments, offset by increased inventory purchases. Investing activities Net cash used in investing activities decreased by $22.2 million for the three months ended March 31, 2024 compared to the prior year period, primarily due to lower net purchases of short-term investments. Financing activities Net cash used in financing activities increased by $9.1 million for the three months ended March 31, 2024 compared to the prior year period, primarily due to the increase in withholding tax from restricted stock unit releases. 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, 2023. There have been no material changes to our critical accounting policies and estimates during the three months ended March 31, 2024, 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. 31 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk During the three months ended March 31, 2024, 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, 2023.