What changed in this filing

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Item 2. Management’s Discussion and Analysis

2024-08-08 compared with 2024-05-09 · 79 added, 59 removed, 184 unchanged (43% of the section changed)

17 unchanged sentences

Since the launch of our first product in December 2014, we have shipped over 34.6 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.

As of June 30, 2024, the Arlo platform had approximately 10.0 million cumulative registered accounts across more than 100 countries around the world coupled with approximately 4.0 million cumulative paid subscribers and annual recurring revenue of $235.0 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 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.

For the three months ended June 30, 2024 and July 2, 2023, we generated total revenue of $127.4 million and $115.1 million, respectively, and loss from operations was $12.8 million and $8.0 million, respectively.

For the six months ended June 30, 2024 and July 2, 2023, we generated total revenue of $251.6 million and $226.1 million, respectively, and loss from operations was $23.4 million and $22.2 million, 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.

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

2024 % Change April 2,

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_________________________

(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.

(1) The number of cumulative paid accounts as of June 30, 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.

As a result, ARR as of June 30, 2024 was calculated using the daily recognition model while ARR as of July 2, 2023 was calculated using our former methodology, the mid-month convention.

ARR as of July 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 .

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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.

Accordingly, the methodology used to calculate ARR was also changed in the first fiscal quarter of 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.

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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.

During the six months ended June 30, 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.

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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:

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2023 June 30,

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and (iii) APAC—and generally base revenue by geographic region on the bill-to location of the customer.

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2023 June 30,

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Revenue by classification is as follows:

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2023 June 30,

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Total revenue $ 127,447 10.8 % $ 115,076 $ 251,647 11.3 % $ 226,080

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.

Product revenue increased by $2.4 million, or 3.8%, and $2.9 million, or 2.2%, for the three and six months ended June 30, 2024 compared to the prior year periods, respectively, 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 and a reduction in average selling prices (“ASPs”) of our products as we increased promotional activities to stimulate household acquisition and subscriber growth.

The increase in product revenue was also attributable to lower sales returns which are partially offset by higher sales incentives that are deemed to be reductions of revenue.

Service revenue increased in all regions by $9.9 million, or 19.7%, and $22.7 million, or 24.1%, for the three and six months ended June 30, 2024 compared to the prior year periods, respectively, primarily due to a 73.9% increase in cumulative paid accounts.

Cost of Revenue

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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.

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

infrastructure to support our cloud-based back-end IT infrastructure.

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 service costs and gross margin and allows us to adapt to changing market dynamics and supply chain constraints.

Three Months Ended

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Total cost of revenue $ 80,593 10.1 % $ 73,218 $ 157,413 5.6 % $ 149,005

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.

Three Months Ended

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Product cost of revenue increased 9.2% and 3.8% for the three and six months ended June 30, 2024, respectively, compared to the prior year periods, primarily due to an increase in product shipments, partially offset by decreases in product warranty reserves and inventory reserves.

Service cost of revenue increased 14.0% and 14.8% for the three and six months ended June 30, 2024, respectively, compared to the prior year periods, primarily due to service revenue growth as a result of the increase in cumulative paid accounts, partially offset by cost optimizations.

Three Months Ended Six Months Ended

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2023 June 30,

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Total gross margin 36.8 % 36.4 % 37.4 % 34.1 %

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.

Product gross profit decreased $3.2 million and $1.9 million for the three and six months ended June 30, 2024, respectively, 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 subscriber growth.

The product gross profit decrease was partially offset by decreases in product warranty reserves and inventory reserves due to subsequent sale of the related inventory units.

Service gross profit increased $8.1 million and $19.1 million for the three and six months ended June 30, 2024, respectively, compared to the prior year periods, primarily due to service revenue growth in all regions as a result of increases in cumulative paid accounts and cost optimizations.

Operating Expenses

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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.

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Research and development expense $ 19,561 11.0 % $ 17,618 $ 40,354 14.1 % $ 35,368

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.

Research and development expense increased by $1.9 million for the three months ended June 30, 2024 compared to the prior year period, primarily due to increases of $1.7 million in personnel-related expenses mainly from stock-based compensation and merit increases and $0.4 million in professional services.

Research and development expense increased by $5.0 million for the six months ended June 30, 2024 compared to the prior year period, primarily due to increases of $3.9 million in personnel-related expenses mainly from stock-based compensation and merit increases, $0.7 million in professional services, and $0.3 million in corporate IT and facilities overhead.

Sales and Marketing

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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.

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Sales and marketing expense $ 17,698 4.6 % $ 16,921 $ 35,068 8.7 % $ 32,274

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.

Sales and marketing expense increased $0.8 million for the three months ended June 30, 2024 compared to the prior year period, primarily due to increases of $0.7 million in personnel-related expenses mainly from stock-based compensation and merit increases, $0.4 million in professional services as a result of continued investment in customer experience improvements across customer care and engineering, and $0.3 million in credit card processing fees as a result of increases in Arlo.com store sales and paid subscriber accounts, partially offset by a decrease of $0.4 million in freight-out expenses.

Sales and marketing expense increased $2.8 million for the six months ended June 30, 2024 compared to the prior year period, primarily due to increases of $1.6 million in personnel-related expenses mainly from stock-based compensation and merit increases, $1.4 million in professional services as a result of continued investment in customer

experience improvements across customer care and engineering, and $0.5 million in credit card processing fees as a result of increases in Arlo.com store sales and paid subscriber accounts, partially offset by a decrease of $0.6 million in freight-out expenses.

General and Administrative

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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.

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General and administrative expense $ 21,430 42.8 % $ 15,007 $ 40,778 33.1 % $ 30,629

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 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

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General and administrative expense increased $6.4 million for the three months ended June 30, 2024 compared to the prior year period, primarily due to increases of $5.4 million in personnel-related expenses mainly from stock-based compensation due to the achievement of performance-based awards target and $0.9 million in professional services.

General and administrative expense increased $10.1 million for the six months ended June 30, 2024 compared to the prior year period, primarily due to increases of $7.3 million in personnel-related expenses mainly from stock-based compensation due to the achievement of performance-based awards target and $2.8 million in professional services.

Others include 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, and separation expense, which consists primarily of costs of legal and professional services.

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

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$ 1,495 79.0 % $ 835 2,881 84.6 % 1,561

Other loss, net

$ (25) ** $ (39)

Other income (loss), net $ (18) ** $ 52 (43) ** 13

**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.

Interest income, net increased for the three and six months ended June 30, 2024 compared to the prior year periods, primarily due to the increase in our short-term investments as well as higher interest rates.

Provision for Income Taxes

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Effective tax rate (2.1) % (3.1) % (3.1) % (4.9) %

The effective tax rate for the three months ended March 31, 2024 was lower than the U.S.

The effective tax rate for the three and six months ended June 30, 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.

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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.

As of June 30, 2024, our cash and cash equivalents and short-term investments totaled $144.0 million and we had unused borrowing capacity of $6.2 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.

As of June 30, 2024, our accumulated deficit was $388.7 million.

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

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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.

As we grow our installed base and related cost structure, there will be a need for additional working capital, hence, we increased our subscription rates effective February 3, 2023.

Leases and Contractual Commitments

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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.

Three Months Ended

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Six Months Ended

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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.

Net cash provided by operating activities increased by $3.4 million for the six months ended June 30, 2024 compared to the prior year period, primarily due to improved profitability offset by unfavorable working capital movements as a result of increased inventory purchases, partially offset by higher trade payable balances due to the timing of payments.

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.

Net cash used in investing activities decreased by $32.9 million for the six months ended June 30, 2024 compared to the prior year period, primarily due to lower net purchases of short-term investments and lower purchases of property and equipment.

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.

Net cash used in financing activities increased by $8.2 million for the six months ended June 30, 2024 compared to the prior year period, primarily due to the increase in withholding tax from restricted stock unit releases and lower 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, 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.

There have been no material changes to our critical accounting policies and estimates during the six months ended June 30, 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.

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.

During the six months ended June 30, 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.

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