Arlo Technologies, Inc. (NYSE:ARLO) Q1 2023 Earnings Call Transcript May 11, 2023

Arlo Technologies, Inc. beats earnings expectations. Reported EPS is $0.01, expectations were $-0.00196.

Operator: 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.

Erik Bylin: Thank you, operator. Good afternoon, and welcome to Arlo Technologies First Quarter 2023 Financial Results Conference Call. Joining us from the company are Mr. Matthew McRae, CEO; and Mr. Kurt Binder, CFO. The format of the call will start with an introduction and commentary on the business provided by Matt. Followed by a review of the financials for the first quarter along with guidance for the second quarter and full year provided by Kurt. We’ll then have time for any questions. If you have not received a copy of today’s 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, expenses, cash outlook, free cash flow and free cash flow margin, guidance for the second quarter and full year of 2023, the rate and timing of subscriber growth, the 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 brand awareness campaign on future growth, partnerships with various market leaders and strategic collaborators, continued new product and service differentiation and the impact of general macroeconomic conditions 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 annual report on Form 10-K and quarterly report on Form 10-Q. Any forward-looking statements that 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.

Matthew McRae: Thank you, Erik. And thank you, everyone, for joining us today on Arlo’s first quarter 2023 earnings call. As I mentioned on our last call, Arlo had crossed an inflection point and our results in Q1 provide a glimpse of the bright future ahead. And while we remain cautious with regards to the overall macroeconomic outlook, the decisive operational actions we took at the end of Q3 combined with our recent product launches and new pricing strategy drove outstanding results and has positioned Arlo to outperform the market. We reached non-GAAP profitability ahead of expectation in Q1. We are guiding to a substantial increase in non-GAAP profitability for Q2. We are raising full-year guidance for 2023 and we expect our profitability and cash position to improve throughout the rest of the year.

This underlines the continuing valuation dislocation for Arlo. We are redoubling our efforts to generate awareness with investors as we execute the business and strategy that is creating our successful trajectory. Looking at Q1 in more detail, revenue came in at $111 million which was above the high end of our guidance and we saw strong demand throughout the quarter thereby driving our inventory lower. Arlo added 182,000 paid accounts and cross the 2 million paid accounts subscriber milestone in Q1. Earlier this year, we adjusted the pricing on our hardware and subscriptions to optimize our ability to drive shareholder value. Lowering hardware prices to sell more units while increasing subscription pricing to accelerate service revenue. The price increases have had an immaterial impact on churn to date and we have seen an upward mix shift across our subscription plans.

These factors drove service revenue up 47% year-over-year to $44 million for the quarter and non-GAAP service gross margin grew 380 basis points sequentially to reach a record 74%. Exiting the quarter, Arlo’s annual recurring revenue grew an incredible 80% year-over-year and reached $183 million. The observed price elasticity and successful upselling is a testament to the value proposition Arlo services bring to our users as well as to the lifetime value of each subscriber. Arlo remains on track to continue our strong pace of subscriber additions and achieve $200 million of service revenue in 2023 at close to 75% non-GAAP gross margin and growing nearly 50% year-over-year. The performance of our service business not only delivered non-GAAP profitability, it drove $9 million of free cash flow in Q1.

And we expect Arlo to generate free cash flow and non-GAAP profitability throughout the year leading to our target of 5% non-GAAP operating margin for full year 2023. Underpinning this achievement is what continues to be heralded by many reviewers as the best cameras and doorbells available on the market. Our innovative technologically advanced portfolio of products propelled Arlo to the top of numerous best of 2023 lists in the quarter and awards from publications, including Diverge, Consumer Reports, Engadget, Wire Cutter, Android Police, Digital Camera World, New York Post, In The No, Pocket Now, Flash Gear, Good Design, Digital Trends, Popular Mechanics and TechJunkie. We have also expanded our product portfolio to include a full security system with an advanced multi-sensor at its core, that provides numerous advantages over the competition.

Arlo’s extensive award-winning product ecosystem is a powerful subscriber acquisition lever that continues to drive new paid accounts. And Arlo Safe, our new personal and family safety service opens new doors for users to enter our ecosystem. A simple download from the Apple or Google app store begins a user’s engagement with Arlo. I am pleased to share that today we announced a partnership with Ping ID, a company known for world-class authentication and corporate security solutions. Ping ID will be providing Arlo Safe as an employee benefit across their company. This reflects an exciting new channel for Arlo to drive paid accounts. All of these services run on Arlo’s SmartCloud platform that provides an unparalleled level of security and performance for our users and partners.

The smart cloud architecture is flexible and scalable, allowing us to quickly bring new features, services and solutions to market as we look to expand our capabilities and offerings over the next 24 months of our long-range plan. And with that, I’ll turn it over to Kurt.

Kurt Binder: Thank you, Matt, and thank you, everyone, for joining us today. I will start by sharing some financial details and an overview of the business for Q1 2023. Revenue for the first quarter came in above the high end of our guidance at $111 million, down 6% sequentially and 11% year-over-year. The decline in revenue was attributed to lower product revenue, a trend which commenced in the second half of 2022 in the face of a softening consumer demand environment. This trend was partially offset by our approach to reducing product prices as a catalyst to household acquisition and subscriber growth. To date, this approach has been effective and has enabled us to maintain strong subscriber additions and deliver strong growth of our highly profitable service revenue.

We are extremely pleased with our services revenue and ARR growth, which helped deliver revenue above our guidance range and strongly contributed to Arlo delivering non-GAAP net operating profit in Q1. Our service revenue for Q1 was another record at $44 million, an increase of $14 million or 47% year-over-year and an increase of $5.6 million or 15% quarter-over-quarter. The increase driven by the addition of 182,000 paid accounts in the quarter coupled with certain in-app enhanced functionality and features, enabled us to increase our subscription plan prices in the quarter. Additionally, our installed base reached a major milestone of 2 million paid account subscribers during Q1, which represents an inflection point in our operating model.

Service revenue accounted for 40% of our Q1 2023 revenue and importantly represented 91% of our total gross profit. Additionally, our quarter-end ARR was $183 million, up 80% year-over-year. And thereby providing greater predictability and visibility into our ability to deliver on near-term revenue and profitability targets. Product revenue for Q1 was $67 million, down 16% sequentially and 29% year-over-year. During the quarter, we shipped a total of 964,000 cameras worldwide with 50% of our revenue coming from our international customers. In fact, we again experienced consistent results in the quarter with our strategic partner Verisure in EMEA with product revenue up 27% sequentially, but slightly down 8% year-over-year. Our strong and collaborative relationship with Verisure continues to be a very important one for us and a great intangible as we explore future growth opportunities together.

From this point on, my discussion points will focus on non-GAAP numbers. The reconciliation from GAAP to non-GAAP figures is detailed in our earnings release distributed earlier today. Our non-GAAP gross profit in the first quarter was $36 million, up 5% year-over-year. This resulted in a non-GAAP gross margin of 33%, up 500 basis points from 28% in Q4 of 2022. The year-over-year increase in non-GAAP gross profit in Q1 was attributable to growth in our service business, as we have brought down product gross margins as part of our overall pricing strategy. The improvement in non-GAAP service gross profit was driven by growth in our ARR or subscription plan pricing and the monetization of our installed base of paid subscribers coupled with cost optimization.

Non-GAAP service gross margin for the quarter was 74% significantly up from 70% in Q4 of 2022 and 65% in Q1 of 2022. Non-GAAP product gross margin for the quarter was 6% and consistent with our guidance provided in March of this year. Total non-GAAP operating expenses for the first quarter were $35 million, down sequentially and up $2 million or 5% year-over-year. The year-over-year increase is attributable to continued investment in sales and marketing expenses to help drive household acquisition and subscriber growth. The non-GAAP operating expenses for the first quarter were slightly better than our expectations and reflect the cost savings initiatives implemented in Q4. Our headcount at the end of Q1 was 334 employees, which represents a decrease from 343 team members at the end of Q4 and 358 team members in the same period last year.

In Q1, we posted non-GAAP net income of $1.1 million. Our non-GAAP net income translates to earnings per diluted share of $0.01, much better than our guidance provided last quarter. The significant improvement in non-GAAP operating margin was driven by a combination of service revenue growth and gross margin expansion coupled with a disciplined approach to cost management. You can expect us to be deliberate and disciplined in managing operating expenses in line with revenue growth and our customer-centric operating model. In Q4, we executed on various initiatives to reduce operating expenses, all of which have proven to be prudent considering the uncertain economic climate. But more so in aligning our organizational structure with the services for strategy.

Regarding our balance sheet and liquidity position, we ended the quarter with one $118.7 million in available cash, cash equivalents and short-term investments. This balance was up nearly $5 million sequentially and is well above the high end of our guidance range provided last quarter. We are pleased to report that we generated approximately $9.4 million in free cash flow in Q1, which represents free cash flow margin of 8.5% driven by our increased profitability and working capital management. Additionally, our Q1 inventory balance ended at $39.9 million, representing a decrease of $6.6 million or 14% from Q4 of 2022 with inventory turns at 6.4x and consistent last quarter. And finally, our accounts receivable balance was $52.8 million as of April 2 with Q1 DSOs at 44 days down from 50 days sequentially and 58 days from the same period last year.

We will continue to monitor our working capital balances in line with our revenue levels with a focus on maintaining a solid balance sheet and liquidity position in the future. Now turning to our outlook. Considering that Arlo surpassed the 2 million paid accounts subscriber milestone this past quarter let me emphasize that the company is upon an inflection point in 2023. The forecasted revenue growth in our service business will drive Arlo to be materially profitable in 2023. Given the current consumer environment, we still remain cautious about our product revenue outlook for the year. With that said, we expect the second quarter revenue for 2023 to be in the range of $105 million and $115 million. We expect our GAAP net loss per diluted share to be between $0.15 and $0.09.

And our non-GAAP net income per diluted share to be between $0.01 and $0.07 per share for Q2 of 2023. For the full year, we reiterate that service revenue is forecasted to grow at roughly 45% year-over-year to approximately $200 million, thereby becoming a much larger portion of our overall revenue and profitability mix. We estimate non-GAAP product gross margin will be in the mid-single digit as we pursue promotional activities and sales models that prioritize the acquisition of new households and subscribers. However, we expect non-GAAP service gross margin to be at or above 75% in 2023. Additionally, we are adjusting upwards our 2023 full year revenue range to be between $470 million to $500 million. And now, I’ll open it up for questions.

Operator: [Operator Instructions] We’ll go first to Jacob Stephan, Lake Street.

Q&A Session

Operator: Next, we’ll hear from Adam Tindle, Raymond James.

Operator: Next up we’ll hear from Hamed Khorsand, BWS Financial.

Operator: That does conclude the question-and-answer session and also concludes today’s conference. We would like to thank you all for your participation. You may now disconnect.