What changed in this filing

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Item 7. Management’s Discussion and Analysis

2025-02-27 compared with 2024-02-29 · 70 added, 82 removed, 193 unchanged (44% of the section changed)

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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 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.

We also expect our sales and marketing expenses 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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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.

We regularly review our processes for calculating these metrics, and from time to time we may discover a need to make adjustments to better reflect our business or to improve their accuracy.

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

As of and for the Year Ended December 31,

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Cumulative paid accounts 4,599 63.5 % 2,813

2,813 51.1 % 1,862

Annual recurring revenue $ 210,078 52.5 % $ 137,764

_________________________

(1) The number of cumulative paid accounts as of December 31, 2023 included paid accounts managed by 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.

Annual recurring revenue (“ARR”) $ 257,332 22.5 % $ 210,078

Cumulative Registered Accounts .

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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 (“ARR”) .

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 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.

ARR represents and is defined as the annualized paid service revenue we expect to recognize from subscription contracts, as calculated by taking the average paid service revenue multiplied by the number of subscription accounts at the end of the reporting period.

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 year ended December 31, 2023, 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.

Components of Results of Operations

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

Our gross revenue consists primarily of sales of devices 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 paid subscription services are billed in advance of the start of the monthly subscription and revenue is recognized ratably over subscription period.

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.

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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 corporate IT and facilities overhead.

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

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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.

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.

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, corporate IT and facilities overhead, strategic initiative expense, and other general corporate expense.

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.

Impairment Charges

During the second quarter of 2021, we reviewed certain of our right-of-use assets and other lease-related assets for impairment in conjunction with our decision to sublease our office space in San Jose, California.

As a result, we recorded an impairment charge for the right-of-use asset and other lease-related assets included in the San Jose office asset group.

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.

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.

Others also include the write-off of deferred financing and separation related expenses, which consist primarily of costs of legal and professional services.

Results of Operations

In this section, we discuss the results of operations for the year ended December 31, 2024 compared to the year ended December 31, 2023.

For a discussion of the year ended December 31, 2022 compared to the year ended December 31, 2021, please refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2022.

The following table sets forth our consolidated statements of comprehensive loss data:

For a discussion of the year ended December 31, 2023 compared to the year ended December 31, 2022, please refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2023, which was filed with the SEC on February 29, 2024.

The following table sets forth our consolidated statements of operations data:

Year Ended December 31,

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Interest income 5,584 1.1 % 3,935 0.8 %

Other income, net 107 0.0 % 302 0.1 %

Other income (expense), net

(104) (0.0) % 107 0.0 %

Loss before income taxes (29,412) (5.8) % (20,861) (4.3) %

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Total revenue $ 510,886 4.0 % $ 491,176

Product revenue decreased by $64.0 million, or 18.1% for the year ended December 31, 2023 compared to the prior year.

The declines were experienced mainly in EMEA and the Americas and were 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.

This decline in revenue was partially offset by the revenue generated from the Essential 2 camera portfolio which was launched in the third quarter of 2023.

Service revenue increased in all regions by $64.8 million, or 47.4%, for the year ended December 31, 2023 compared to the prior year, primarily due to a 51.1% increase in cumulative paid accounts and an approximated 30% increase in rates for our subscription plans.

Product revenue decreased by $22.1 million, or 7.6% for the year ended December 31, 2024 compared to the prior year, primarily driven by the decrease in product sales in two geographic regions Americas and APAC.

The decline in product sales is driven by a reduction in average selling prices (“ASPs”) of our products as we increased promotional activities to stimulate household acquisition and subscriber growth, and the increase in related sales incentives that are deemed to be reductions of revenue.

The decline was partially offset by the increase in product sales in EMEA due to stronger customer demand and the lower sales returns that are deemed to be reductions of revenue.

Service revenue increased in all regions by $41.8 million, or 20.8%, for the year ended December 31, 2024 compared to the prior year, primarily due to a 63.5% increase in cumulative paid accounts and the continued increase in average revenue per user (“ARPU”) of retail subscriptions.

Cost of Revenue

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Total cost of revenue $ 323,382 (0.1) % $ 323,613

Cost of product revenue decreased for the year ended December 31, 2023 compared to the prior year, 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.

Cost of service revenue increased for the year ended December 31, 2023 compared to the prior year, primarily due to service revenue growth as a result of increases in cumulative paid accounts and rates for our subscription plans, partially offset by cost optimizations.

Cost of product revenue decreased for the year ended December 31, 2024 compared to the prior year, primarily due to a decline 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 product warranty and inventory reserves.

Cost of service revenue increased for the year ended December 31, 2024 compared to the prior year, primarily due to service revenue growth as a result of the increase in cumulative paid accounts, partially offset by cost optimizations.

Year Ended December 31,

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Total gross margin 36.7 % 34.1 %

Product gross profit decreased for the year ended December 31, 2023 compared to the prior year, 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 year ended December 31, 2023 compared to the prior year, 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 for the year ended December 31, 2024 compared to the prior year, primarily driven by a reduction in the ASPs on our products as we increased promotional activities to stimulate household acquisition and subscriber growth coupled with an increase in inventory reserves.

Service gross profit increased for the year ended December 31, 2024 compared to the prior year, primarily due to service revenue growth in all regions as a result of increases in cumulative paid accounts, continued increase in ARPU of retail subscriptions, and cost optimizations.

Operating Expenses

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Research and development expense $ 73,183 6.6 % $ 68,647

Research and development expense increased $3.9 million for the year ended December 31, 2023 compared to the prior year, primarily due to increases of $3.0 million in personnel-related expenses mainly from compensation recorded as a result of an increase in headcount and $2.1 million in outside professional services, partially offset by a decrease of $0.6 million in corporate IT and facilities overhead.

Research and development expense increased by $4.5 million for the year ended December 31, 2024 compared to the prior year, primarily due to an increase of $5.3 million in personnel-related expenses mainly from stock-based compensation and merit increases, partially offset by a decrease of $0.6 million in corporate IT and facilities overhead.

Sales and Marketing

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Sales and marketing expense $ 73,723 11.5 % $ 66,141

Sales and marketing expense decreased $3.9 million for the year ended December 31, 2023 compared to the prior year, primarily due to a decrease of $9.2 million in marketing expenditures as a result of the suspension of our brand

awareness advertising campaign, partially offset by increases of $2.1 million in credit card processing fees as a result of increases in Arlo.com store sales and paid subscriber accounts, $2.1 million in customer care services as we continue to invest in improving our customer experience, and $1.8 million in freight-out expenses due to increase in customer shipment volume in Arlo.com store.

Sales and marketing expense increased by $7.6 million for the year ended December 31, 2024 compared to the prior year, primarily due to increases of $4.0 million in personnel-related expenses mainly from stock-based compensation and merit increases, $3.1 million in marketing expenditures, $1.5 million in credit card processing fees as a result of increases in paid subscriber accounts, and $0.9 million in professional services as a result of continued investment in improved customer experience, partially offset by a decrease of $1.6 million in freight-out expenses.

General and Administrative

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General and administrative expense $ 72,134 28.0 % $ 56,371

General and administrative expense increased $0.4 million for the year ended December 31, 2023 compared to the prior year, primarily due to an increase of $2.2 million in personnel-related expenses mainly from stock-based compensation and merit increases, partially offset by a decrease of $1.8 million in corporate IT and facilities overhead and professional consulting services.

Interest Income and Other Income, Net

General and administrative expense increased by $15.8 million for the year ended December 31, 2024 compared to the prior year, primarily due to increases of $12.3 million in personnel-related expenses mainly from stock-based compensation as a result of the achievement of certain performance-based equity award targets, $2.0 million in legal and professional services, and $0.8 million in corporate IT and facilities overhead costs.

Interest Income and Other Income (Expense), Net

Year Ended December 31,

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Interest income, net $ 5,584 41.9 % $ 3,935

Other income, net $ 107 ** $ 302

Other income (expense), net

$ (104) ** $ 107

**Percentage change not meaningful.

Interest income, net increased for the year ended December 31, 2023, compared to the prior year, primarily due to the increase in our short-term investments as well as a result of higher interest rates.

Interest income, net increased for the year ended December 31, 2024, compared to the prior year, primarily due to the increase in our cash and cash equivalents and short-term investments as well as higher interest rates.

Provision for Income Taxes

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Effective tax rate (3.7) % (5.6) %

Provision for income taxes was primarily attributable to income taxes on foreign earnings and to a lesser extent U.S.

taxable income.

The increase in provision for income taxes for the year ended December 31, 2023 compared to the prior year was primarily due to (i) the higher U.S.

earnings, and (ii) the application of Section 174 of the Internal Revenue Code requiring capitalization of research and experimental expenses.

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.

The effective tax rate for the year ended December 31, 2024 was lower than the U.S.

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Liquidity and Capital Resources

As of December 31, 2023, our cash and cash equivalents and short-term investments totaled $136.5 million, and we had unused borrowing capacity of $13.9 million based on the terms and conditions of our revolving credit facility.

As of December 31, 2024, our cash and cash equivalents and short-term investments totaled $151.5 million.

Additionally, on November 14, 2024, we entered into the Credit Agreement, which provides for a three-year revolving credit facility of up to $45.0 million that matures on November 14, 2027.

As of December 31, 2024, we had unused borrowing capacity of $45.0 million based on the terms and conditions of the Credit Agreement.

The proceeds of the borrowings under this credit facility may be used for working capital and general corporate purposes.

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

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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 may increase our product and subscription rates in the future.

Leases and Contractual Commitments

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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 Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K for further information about our operating leases, purchase obligations, and legal contingencies.

Refer to Note 8, Commitments and Contingencies in the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K for further information about our operating leases, purchase obligations, and legal contingencies.

Stock Repurchase Program

Our Board of Directors has authorized a stock repurchase program of up to an aggregate of $50.0 million of shares, which commenced in September 2024 and is expected to continue through December 31, 2026 unless extended or shortened by the Board of Directors.

In the fourth quarter of fiscal 2024, we repurchased and subsequently retired 378,745 shares of our common stock for an aggregate purchase price of $4.4 million.

As of December 31, 2024, $45.6 million remained available and authorized for future repurchases.

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

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(In thousands)

Net cash provided by (used in) operating activities $ 38,302 $ (45,962)

Net cash used in investing activities (50,686) (31,773)

Net cash provided by operating activities

$ 51,306 $ 38,302

Net cash provided by (used in) investing activities

10,840 (50,686)

Net cash used in financing activities (40,767) (15,142)

Net cash decrease $ (27,526) $ (91,677)

Net cash increase (decrease)

$ 21,379 $ (27,526)

Operating activities

Net cash provided by (used in) operating activities increased by $84.3 million for the year ended December 31, 2023 compared to the prior year period, primarily due to improved profitability driven by growth in paid accounts and increased subscription rates and changes in working capital as a result of lower inventory and trade payable balances and increase in deferred revenue.

Net cash provided by operating activities increased by $13.0 million for the year ended December 31, 2024 compared to the prior year period, primarily due to improved profitability coupled with favorable working capital movements as the results of (i) higher accounts receivable collections due to the growth of our sales;

(ii) higher accounts payable balances mainly due to timing of the payments;

and (iii) increase in deferred revenue due to the growth in our service subscription paid accounts and subscription rates expansion, partially offset by increased inventory purchases.

Investing activities

Net cash used in investing activities increased by $18.9 million for the year ended December 31, 2023 compared to the prior year period, primarily due to increases in net purchases, and maturities of short-term investments and in purchases of property and equipment.

Net cash provided by (used in) investing activities increased by $61.5 million for the year ended December 31, 2024 compared to the prior year period, primarily due to higher proceeds from maturities of short-term investments.

Financing activities

Net cash used in financing activities slightly increased by $1.2 million for the year ended December 31, 2023 compared to the prior year period, primarily due to an increase in withholding tax from restricted stock unit releases, partially offset by higher proceeds related to employee benefit plans.

Net cash used in financing activities increased by $25.6 million for the year ended December 31, 2024 compared to the prior year period, primarily due to an increase in withholding tax from RSU releases and the repurchases of common stock.

Critical Accounting Estimates

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We also discuss our critical accounting estimates with the Audit Committee of our Board of Directors.

Note 2, Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K describes the significant accounting policies and the effect on our consolidated financial statements.

Revenue Recognition

Revenue from all sales types is recognized at transaction price, the amount we expect to be entitled to in exchange for transferring goods or providing services.

Transaction price is calculated as selling price net of variable consideration which may include estimates for sales returns, sales incentives, and price protection related to current period product revenue.

In determining estimates for sales returns, management analyzes certain factors, including historical sales

and returns data, channel inventory levels, current economic trends, and changes in customer demand for our products.

Sales incentives and price protection are determined based on a combination of the actual amounts committed and estimated future expenditure based upon historical customary business practice.

Typically, variable consideration does not need to be constrained as estimates are based on predictive historical data or future commitments that we plan and control.

However, we continue to assess variable consideration estimates such that it is probable that a significant reversal of revenue will not occur.

Our standard warranty obligation to our direct customers generally provides for a right of return of any product for a full refund in the event that such product is found to be damaged or defective.

At the time we recognize revenue, we record an estimate of sales warranty returns to reduce revenue in the amount of the expected credit or refund to be provided to our direct customers as a contra revenue, and we record a write-down to reduce the carrying value of such products to net realizable value as cost of revenue.

Because our products are manufactured by third-party manufacturers, in certain cases we have recourse to the third-party manufacturer for replacement or credit for the defective products.

We give consideration to amounts recoverable from our third-party manufacturers in determining our warranty liability.

Our estimated allowances for product warranties can vary from actual results, and we may have to record additional contra revenue or cost of revenue, which could materially impact our financial position and results of operations.

As of December 31, 2023 and 2022, accrued sales warranty returns amounted to $16.6 million and $17.7 million, respectively.

We recognize sales incentives offered to customers as a marketing expense if we receive an identifiable benefit in exchange and can reasonably estimate the fair value of the identifiable benefit received;

otherwise, it is recognized as a contra revenue.

Consequently, we recognize a substantial portion of sales incentives as channel marketing costs accounted as a contra revenue.

We accrue estimated contra revenue or marketing expense for sales incentives when the related revenue is recognized or ahead of customer or end customer commitment if customary business practice creates an implied expectation that such activities will occur in the future.

Revenue from all sales types is recognized at transaction price, which is the amount we expect to be entitled to in exchange for transferring goods or providing services.

Transaction price is calculated as selling price net of variable consideration which may include estimates for sales returns and sales incentives related to current period product revenue.

Sales returns are estimated by analyzing certain factors, including historical sales and returns data, channel inventory levels, current economic trends, and changes in customer demand for our products.

Sales incentives are determined based on a combination of the actual amounts committed and estimated future expenditure based upon historical customary business practice.

Generally, our direct customers have a right of return for any product within 30 days of purchase for a full refund.

Our standard warranty obligation to our retailers and wholesale distributors allows for returns of damaged and defective products only.

At the time we recognize revenue, we record an estimate of sales returns to reduce revenue in the amount of the expected credit or refund to be provided to our customers as a contra revenue.

Our estimated allowances for product warranties can vary from actual results, and we may have to record additional contra revenue, which could materially impact our financial position and results of operations.

As of December 31, 2024 and 2023, accrued sales returns amounted to $10.6 million and $16.6 million, respectively.

Sales incentives that are mutually agreed with customers are recognized as contra revenue while marketing expenses paid to the third parties are recognized as a marketing expense.

We accrue estimated contra revenue or marketing expense for these sales incentives either when the related revenue is recognized or prior to customer commitment if customary business practice creates an implied expectation of future activities.

As of December 31, 2024 and 2023, accrued sales incentives amounted to $31.9 million and $28.2 million, respectively.

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Long-lived assets, including property and equipment and operating lease right-of-use assets, are reviewed for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable.

Recoverability of these assets is measured by a comparison of the carrying amounts to the anticipated undiscounted value of the assets are expected to generate from the use and eventual disposition.

Recoverability of these assets is measured by a comparison of the carrying amounts to the assets and related cash flows that they are expected to generate from the use and eventual disposition.

If such review indicates that the carrying amount of property and equipment and operating lease assets is not recoverable, the carrying amount of such assets is reduced to the fair value.

During the year ended December 31, 2023 and 2022, no impairment of long-lived assets has been identified.

During the years ended December 31, 2024 and 2023, no impairment of long-lived assets has been identified.

Valuation of Goodwill

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We operate as one operating and reportable segment.

In the annual assessment, a qualitative assessment was performed in consideration of macroeconomic conditions, industry and market conditions, cost factors, overall company financial performance, and c hanges in our stock price.

We believed that it was more-likely-than-not that the fair value of the reporting unit was greater than the respective carrying value and therefore performing the next step of impairment test for the reporting unit was unnecessary.

In the annual assessment, a qualitative assessment is performed in consideration of macroeconomic conditions, industry and market conditions, cost factors, overall company financial performance, and c hanges in our stock price.

We believed that it was more-likely-than-not that the fair value of the reporting unit is greater than the respective carrying value and therefore performing the next step of impairment test for the reporting unit was unnecessary.

If there are events occurred or circumstances changed (i.e.

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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-K

Item 7. Management’s Discussion and Analysis