Arlo Technologies, Inc. (ARLO) Q1 2022 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. [Operator Instructions] I would now like to turn the conference over to Erik Bylin. Please go ahead, sir.

Thank you, operator, good afternoon and welcome to Arlo Technologies’ First Quarter of 2022 Financial Results Conference Call. Joining us for the Company are Mr. Matthew McRae, CEO; and Mr. Gordon Mattingly, CFO. The format of the call we will start with an introduction and commentary on the business provided by Matt, followed by review the financials for the first quarter, along with guidance, the second quarter provided by Gordon. We will then have time for any questions. If you have not received a copy of today’s press release, please visit Arlo’s Investor Relations website at Investor arlo.com. Before we begin the formal remarks, we advise you that today’s conference call contains Forward-Looking Statements. Forward-looking statements include statements regarding our potential future business, operating results and financial condition, including descriptions of our revenue, gross margins, operating margins, earnings per share, tax rates, expenses, cash outlook, guidance for the second quarter of 2022, transition to a services-first business model, the commercial launch and momentum of new products and services, strategic objectives and initiatives, market expansion and future growth, the effect of our anticipate awareness campaign on future growth, partnership with Verisure and Calix, continued new product and service differentiation, supply chain challenges, transportation costs and the impact of COVID-19 pandemic on our business, operating results and financial condition. Actual results or trends could differ materially from those contemplated by these forward-looking statements. For more information, please refer to the risk factors discussed in Arlo’s periodic filings with the SEC, including the most recent quarterly report on Form 10-K and quarterly report on Form 10-Q. Any forward-looking statements we make on this call are based on assumptions as of today and Arlo undertakes no obligation to update these statements as a result of new information or future events. In addition, several non-GAAP financial measures will be discussed on this call. A reconciliation of the GAAP to non-GAAP measures can be found in today’s press release on our Investor Relations website. At this time, I would now like to turn the call over to Matt.

Thank you, Erik, and thank you everyone for joining us today on Arlo’s first quarter 2022 earnings call. My comments will be focused on our record breaking results in Q1 and a summary of our growth drivers going forward. For more detail on our plans, please refer to our most recent Investor Day presentation. Our transformation continues to produce results that outperformed Q1 expectations across all metrics. Total revenue reached $124.8 million, up 51% year-over-year and well above the top end of our guidance. Service revenue reached $29.9 million up 31% year-over-year and marked a record for the 11th consecutive quarter. Total paid accounts were up 132% year-over-year, with Arlo adding 205,000 paid accounts in the quarter, which represents an increase of 8% sequentially, and 80% year-over-year. Our annualized recurring revenue or ARR, achieved a significant landmark by breaking through $100 million, exiting Q1 at $101 million and growing 74% year-over-year. As a reminder, our ARR is the fastest growing and highest margin portion of our service revenue and represents the annualized recurring service revenue we derive from our paid accounts. Despite the additional costs driven by the pandemic supply chain disruptions, we posted our highest ever non-GAAP gross profit of $34.5 million and our second consecutive quarter of non-GAAP operating profit outperforming the high end of our guidance for non-GAAP EPS which came in at a profit of $0.01 per share. These exceptional Q1 results flow from the incredible transformation at our low and our focus on a services first strategy, where roughly two thirds of our hardware buyers become subscribers. As we shared last quarter, the accounts we capture domestic retail have an ARPU of $9.35 per month, and when combined with our low world class churn metrics, translates to an LTV of $550 per user based on Q4 2021 data. Looking ahead, Arlo is executing a new long range plan as described at our most recent Investor Day that focuses on three primary areas of the business to drive revenue growth, margin expansion and through that shareholder value. First, while our best-in-class products and services generate significant accolades, the number one reason people don’t buy Arlo products is because they have not heard of Arlo. We will begin to invest in a brand awareness in a targeted manner, focused on new household formation and driving incremental subscriptions. Second, we are expanding our product portfolio to address new segments and new markets. We expect Arlo Safe will launch in Q3 and provide personal protection for an individual or entire family. And in Q4, we plan to launch our new innovative security system that brings full sensor based security functionality to our ecosystem of smart cameras. Both of these new segments provide significant opportunities to drive new subscriptions and grow our ARPU. And third, we will continue to broaden our routes to market. Our most prominent example of this to-date has been our Verisure relationship, which has been very successful driving outsized growth in Europe, and only looks more promising going forward. We also formed a partnership with Calix last year in which Calix integrated Arlo services into their platform to broadband service providers around the country. To-date 29 broadband service providers are signed up and we are excited to ramp this in the coming year. As we execute these growth strategies and work to realize our new three to five-year targets of five million paid accounts $300 million in ARR, and double-digit operating margin, Arlo will exhibit the same discipline that we demonstrated as we transformed our business. And with that, I would like to hand the call over to Gordon, who will provide more insight into our financial performance, operational details and outlook for the second quarter.

Thank you, Matt. And thank you, everyone for joining today. We delivered strong Q1 2022 financial results that exceeded our expectations, growing our revenue by 51.1% year-over-year and above the high end of our guidance. While growing non-GAAP gross profit sequentially, and year-over-year to a record for the Company $34.5 million. Our financial performance for the quarter with again underpinned by the successful execution of our services business model, leading to record levels of paid accounts. The Arlo team navigated continuing tough supply conditions exceeded our expectations on revenue while improving our year-over-year, non-GAAP operating profitability by $4.1 million and posting our second consecutive quarter of non-GAAP operating profit. And now moving on to the Q1 financial detail. Revenue came in at a first fiscal quarter record of $124.8 million up 51.1% year-over-year and down only $0.127 sequentially. These strong sequential revenue result clearly demonstrates how channel diversification and ARR growth are benefiting the business. Our service revenue for Q1, 2022 was a record $29.9 million, up 5.1% sequentially and 31.3% year-over-year with our services first business model fueling our growth. While service revenue accounted for 24% of our Q1 2022 revenue, it delivered 56.8% of our non-GAAP gross profit. Our service revenue also includes $0.1 million of NRE services we are providing for very short, along with associated costs, as compared with $1.1 million in the fourth quarter of 2021. Product revenue in Q1 2022 was $94.8 million, which was up 58.7% year-over-year and down 17.1% sequentially. Our year-over-year product revenue growth was driven by continued strength from our very short relationship in Europe, coupled with growth in retail in Americas, where we were pleased to bring retail channel inventory back up to more normal levels. During first quarter, we shipped approximately one million devices, all of which were cameras. From this point on, my discussion points will focus on non-GAAP numbers. The reconciliation from GAAP to non-GAAP is detailed in our earnings release distributed earlier today. Our non-GAAP gross profit for the first quarter of 2022 was, up $7.8 million year-over-year and up $1.8 million sequentially to $34.5 million, which resulted in a non-GAAP growth margin of 27.6%, down from 32.3% in Q1 2021, and up 4.7 percentage points from 22.9% in Q4 2021, a $7.8 million year-over-year improvement in non-GAAP gross profit included an improvement of $6.4 million from services and $1.4 million from products. The improvement in non-GAAP service growth profit was driven by growth in our ARR, coupled with cost optimization. The improvement in non-GAAP product growth profit was driven by higher revenue, more than offsetting an incremental $3.3 million of air freight expense, due to COVID-19 related supply chain challenges. Non-GAAP service growth margin came in at a record 65.4%, significantly up from 57.9% in Q1 2021 and an improvement on 63.2% in Q4 2021. Non-GAAP product growth margin was 15.7%, down from 22.6% in Q1 2021, mainly due to year-on-year increase of $3.3 million in air freight expense, and up from 12.9%, sequentially helped by a $3.1 million reduction in air freight expense. Total non-GAAP operating expenses were $33.4 million, up $4.3 million or 14.7% sequentially, and up $3.7 million or 12.4% year-over-year. As we invest in R&D ahead of our new product and service introductions and lay the groundwork for our upcoming awareness campaign. Our total non-GAAP R&D expense for the first quarter was up $2.8 million sequentially at $14.1 million. Our headcount at the end of Q1 was 358 employees, compared to 353 in the prior quarter. As a reminder, during the early stages of a Verisure relationship, we agreed to provide them with transition services, which include training with all our employees, as well as systems costs and some outside service costs. We have included these costs in our normal operating expenses. The reimbursement from Verisure included in other income, and was approximately $0.4 million during Q1. Our non-GAAP tax expense for the first quarter of 2022 was $0.2 million. In Q1, we posted a non-GAAP net profit per diluted share of $0.01, much better than our guidance, and a $0.04 improvement year-over-year. We ended the quarter with $145.5 million in cash, cash equivalents and short-term investments, down $30.2 million sequentially and down $31.6 million year-over-year. The sequential reduction was driven by reductions in accounts payable, in line with sequentially lower product purchases and deferred revenue in line with Verisure prepaid product purchases. Q1 inventory flow at $37 million, a decrease of $1.4 million over Q4 2021 with turns at 8.7 as compared to 10.5 last quarter and 3.4 a year ago. Our DSO came at 58-days, up from 54-days a year ago, and up from 50-days sequentially, with the increase driven by customer mix. Now, turning to our outlook. We expect second quarter revenue to be in the range of $105 million to $115 million. We expect our GAAP net loss per diluted share to come in between $0. 19 and $0.14 per share. Now our non-GAAP net loss per diluted share come in between $0.08 and $0.03 per share. Our guidance includes approximately $1.2 million of awareness payment as we develop content and messaging ahead of starting our campaign in earnest in the third quarter, in line with what we communicated in our Analysts Day in March. In line with previous guidance, we expect to end the year with $110 million $120 million in cash, cash equivalents and short-term investments. And we will continue to monitor our performance and prudently manage our operations to preserve our cash position. And now, I will open it up for question.

[Operator Instructions] Your first question comes from the line of Catherine Huntley with Raymond James. Your line is open.

Hi guys, congratulations ion a great quarter. This is Catherine on for Adam. Could you talked about the weeks of channel inventory and how they are elevated globally? And could you maybe speak to why we are seeing channel inventory increase while supply is still very tight? And how can we think about the financial impact of this normalizing?

Yes, sure. Looking at the time inventory, typically, let’s break it out into the relevant parts. So looking at America’s retail ended, just over 15-weeks. We would typically target 10 to 14 weeks of stock in the channel via a normal level for retail. So we are just a little bit above the target range, but not by much. And quite frankly, we are actually happy for it to be there. We did get stopped towards the end of the quarter, and the denominator in that calculation is last six-weeks and sell through. So you are looking at a situation where inventory was filled towards the end of the quarter and the sell through before that was slightly depressed due to a shortage of inventory. So I think that is the context you need for the Americas retail inventory, we think it is actually pretty normal level. And quite frankly, we are quite pleased to have it at that level, compared to where it has been. Then if we look at APAC, APAC distribution is a little bit on the high side. But you need to appreciate AIPAC distribution as a very relatively immaterial part of our business. So from $1 perspective, it is not very meaningful. We are making a small destock in APAC in Q2, and that is already reflected in the guide, but it is certainly not material. So overall, I think we are pretty well positioned from a challenge inventory perspective, I don’t see anything concerning that at all.

Perfect. Thank you so much for that color. And you have previously laid out your discretionary plan for brand awareness in which you will be spending about 10 million per quarter. And you spoke about this on the tail end of the call. What are the learnings so far that you have had as you approach this investment, given that it is coming out. And how can we think about the timing and magnitude? What has changed since the last call?

Yes, great question. Yes, so we are still committed to doing the stem that we talked about at the Analyst Day and it just was a reminder, it is a, you know, it is a relatively small defined spend from an amount perspective, but also from a time perspective. So the last six months of the year, you know, we are doing that $20 million, fine, like you articulated, just in your question. And then look at those results at the end of end of the year, going into next year to determine where we want to adjust that going forward. The ultimate metric from the spend will be incremental pay accounts, right, that is driving the LTV and the shareholder value in the company. So we are committed to this well defined and kind of disciplined spend in the second half. As we have been planning it, there hasn’t been a lot of changes. We are looking for changes in the media landscape. And we are looking for some of that, as we’ll get into closer to the spend, which is going to be in Q3 as Gordon articulated. But right now, there hasn’t been any changes since the Analyst Day. And we are looking forward to not only executing that spend, but sharing the results of that at the end of the year.

Great. It is always a pleasure and keep up the great work.

Thank you very much.

Thank you.

Your next question comes from the line of Hamed Khorsand with BWS Financial. Your line is open.

Hi. I just want to know about the paid users of the amount the growth you saw this quarter. Does that include anything from your partners Verisure or the 29 broadband service providers?

Yes, it is across but a lot of those gains are obviously from the retail holiday season. Right. You know, we have a 90-day free trial. And so, a lot of the paid or POS that we see, that comes from the holiday period. Those accounts tend to become paid accounts in the Q1. So, you are seeing some of that, obviously growth is coming from retail, coming on the 90-day, post-trial after purchases in the holiday period. And we have seen a growth Verisure, we have mentioned that, the custom camera is starting to ramp and you are seeing that in some of the results from a revenue mix perspective. And as you know, some of the direct business that we do with Verisure is a one-to-one on paid account. I would say those are the two primary areas of growth in paid accounts. We are starting to see Calix ramp, but I think that will take longer before it is really material in the paid accounts. We did share on the call that we now have 29 BSPs or broadband service providers that are now active at least from an onboarding perspective through Calix. We expect that number to continue to ramp. So I think the contribution from Calix will be later in the year, going into the following year, as a lot of these strategic accounts, kind of take a while to ramp.

Is the contribution from Verisure something like a step-up every quarter, or is it going to be lumpy?

It is a little bit more steady, what we see from Verisure because while the retail paid accounts will at some point follow some seasonality, like we were talking about, right. A lot of hardware sold in Q4 will drive paid accounts in Q1. And you will see some seasonality in at least the growth on paid accounts from a normal retail business. Verisure’s direct business, which is beginning to ramp especially with the custom camera we launched last year will be a little bit more steady quarter-over-quarter, because it doesn’t really adhere to the normal promotional periods you would see in a traditional consumer channel. I don’t think we have seen a huge impact of that yet, but that is an effect I think we will see as we continue to ramp the direct business with Verisure over time.

Okay. And I didn’t hear you say this in the script, but are you still at 50% conversion rate from hardware?

Yes. So, those numbers really haven’t changed. So what - we have two metrics that I think we have shared in the past. One is that initial conversion rate, which is what you are talking about, which is right about 50%, and that is really a measure of how many people have signed up in the free trial and the 30-days post of that free trial expiring. So, that first 120 days from the hardware activation, that is 50%. And then we have shared, uh, what we call the six month cohort and we count that as an attach rate, so what we have done is we follow different populations across our different products and channels and everything. And those are all consistent as well, roughly around what we shared in the script, roughly that 65%, almost two-thirds of hardware purchasers, six months later in a cohort analysis are attached to service at that time. So, we do still have, it rises from 50% to that 65% over some additional time as some people are signing up after that initial conversion period.

Okay. great, thank you.

You are welcome.

Your next question comes from the line of Jeff Osborne with Cowan & Co. Your line is open.

Good afternoon guys. A couple questions. I was wondering if you could sort of postmortem diagnose where the upside came from in the quarter relative to initial expectations. I heard two rationale on the call. One was the supply chain management and then also us retail channel. I wasn’t sure if both of those were the source of upside or one versus the other?

Yes. It is a combination. I think you nailed it pretty well. We were able to get a little bit more supply than what we are expecting at the time of the guide that definitely helped. And as we talked about earlier, we were able to get conditional inventory, very welcome inventory into the U.S. retail channel in particular, which was also not something we had visibility into at the time we guided. So, it was really at the time we guarded those really those two things, but largely just tied to supply availability.

And then Gordon, how does have anything changed in the last 4 to 5 weeks with the lockdown in China and some other components that go back and forth from China to Southeast Asia to be made in packages? Just curious, what the COVID shutdown in China does to the ever aging, battle of supply chain management, pretty focused industry more broadly?

Well, it certainly doesn’t make it easier. We obviously manufacture as you know in Vietnam and LaTam. And we do have component, obviously being manufactured, limited components manufactured in Shanghai, I’d say we have seen a little bit of impact there. Not a large amount, the impact you have seen has been reflected in the guide anyway., the one interesting one that we do see is congestion actually crossing the border, from China into Vietnam, that is definitely stepped up in light of lockdown. That is an additional challenge that we face. And we are just looking at alternative routes to get those components into Vietnam. But other than that we haven’t seen much to the downside. So far, I say so far. But on the right side, we are seeing some nice reductions in air freight rates, we are seeing some nice reductions in sea freight rates. We are actually seeing those transit time from Vietnam, for example, to the U.S., those who come down from kind of pandemic heights of 70-day transit times down to something more like 50-days, which is welcome news. So that part of it heading in the right direction. And yes, you rightly said the lockdowns in China are having a slightly negative effect.

Got it. And the last question I had was just yet a helpful chart showing the DIY market share growth over the past few was three years in the deck. I was wondering, within DIY, camera market and security market what you felt your share has been over the past three years? Just report some helpful metrics there.

Yes. It is changing, it is hard to do an apples-to-apples comparison, because some of the key market studies that actually present that as from a third-party perspective, like NPD actually changed the way that they calculated though. And they started bringing in firstparty.com, and some other things that are reported by some but not by others. In general, we have been holding share, I would say for quite a while, over the last two years or so. And it really goes up and down based on promotional timing, both our promotional timing, but also the promotional timing of our competitors. Haven’t seen a lot of real big movements, recently. When we moved initially to the subscriber first, the kind of services first strategy inside the Company. We did see a decline in market share back in that time period. And that was expected and kind of built in, we decided to focus on the customers, market segments, price segments, and channels, that we are going to deliver subscribers and start to de emphasize some of the price segments in the channels we are really just selling hardware and there was not a high propensity to subscribe to service after the hardware purchase. So we saw that initial decline and then kind of laid into a relatively consistent share over the last couple of time periods. So I haven’t seen any real big movement. We haven’t seen a lot of movements in the market in general from competitive behavior anything else.

Thanks. I appreciate the thoughts. That is all I had.

Your next question comes from the line of Mark Argento with Lake Street Capital. Your line is open.

Good afternoon, guys, just a couple of quick ones. First on gross margins, beat our numbers nicely or estimates, and do you anticipate given the current environment, you are going to be able to maintain kind of that 26, 27 level going forward any thoughts around the trend there?

Hey, Mark, Gordon here, I would look at it separately, breaking it out between service revenue, and product revenue. And I think the guidance we have already given on both those stays in place. On service revenue, we have guided 60% to 65%. We still stick to that. It was nice to come in slightly above that, in Q1, we did benefit in Q1 a little bit from mixed benefit just with the Verisure and are even slightly lower proportion of the mix in Q1. But we stick to the guidance we have given 60% to 65%, on the service, gross margin, and on the product side of things. Low to mid teens is where we see it. From ticking down a little bit from where we were at Q1 and Q2. But I think low to mid teens on the product side of things is where we see it panning out. So not vastly different to what the actual results you saw in Q1. That is the guidance we have given to the year.

Great. It is helpful. And then you had mentioned the 29 ESPs by the Calix relationship, if you launch additional products, in particular the full security suite, are those going to go through that channel as well? How do you think about products and channel distribution?

Yes, it is a great question. I mean, like the Calix relationship. It is a very positive one. And I think we have mentioned in the past that we feel it is helping us reach households that are probably underserved from some of our channels. These tend to be more rural or smaller areas of the country that may not have a Best Buy or a Costco nearby it, just as you know, as an example. And so, what I can say is Calix and Arlo, we have done a pretty deep integration on the back, it is one of the reasons why, you know, the ramp takes them a while, there’s a lot of technical integration in the back. And so we look at the products and additional services as a layer on top of that, and a great way to kind of leverage the work that is been done on the initial integration. So the cameras, as you know are rolling out. And that is what we are kind of talking about different DSPs that are signing up. And last quarter, I think we mentioned at the Investor Day, we did announce that Calix is also committed to rolling our security system. And so that will be longer, because there’s an additional integration that needs to happen. So we didn’t release a date yet, but they are committed, and we are committed with them to deploy the security system, in addition to our cameras over time. And that is what is great about some of these partnerships is they are typically not focused on a single product. They’re focused on a longer term relationship that cuts across products, especially after you have done the kind of deeper platform integration work. And so they have kind of paid dividends over time. And we are going to see that with Calyx over the next year or so.

Great. And just one, one final one in terms of supply chain and other component availability is still an issue broadly, but any concern that you are not going to be able to get the security products out by, the second half of this year, get some confidence that you can source what you need?

Yes. So, just in a general level, I think Gordon did a great job kind of breaking down where we see freight, because that is part of this as well. So from a freight perspective, we are seeing improvement. And we are seeing that, as Gordon mentioned, both in cost and in time for delivery, but actual transit time is coming into us. So that is actually helping us because when the transit time is shorter, that means component purchasing can happen later which actually helps on the component side when things are short. And that is why I bring that up. Components, you are correct, absolutely. Components are still relatively type. It is not across the board. It is kind of hit and miss in different areas. We have been forecasting the security system from a component level perspective for quite a while. I think we have mentioned on the Investor Day one of the questions that, we tend to take our forecasting at a component level almost out 50 weeks to give our component suppliers a lot of visibility. And we have done that on the security system as well. So at this time we are confident that, we have got the supply that we need to launch the product in Q4 and have already forecasted Q1 and Q2 into the system as well.

Great. Thanks guys.

You are welcome.

Thank you.

And we have no further questions. I will turn the call back to Matthew McRae for closing remarks.

Thank you, operator. I would like to just take a moment to thank all of the teams at Arlo. I know a lot of them listen in for the hard work to deliver such an amazing result for Q1. We are at the beginning of our new long range plan that we described last quarter and Q1 was an absolutely outstanding start. So thank you to the team and thank you for everyone joining the call today.

This concludes today’s conference call. Thank you for joining. You may now disconnect.