Q3 2022 Arlo Technologies Inc Earnings Call
Ladies and gentlemen, thank you for standing by.
Time, all participants are in a listen only mode.
We will conduct a question and answer question I thought I would like to ask the question.
The star one on your push button.
I would now like to turn the conference over to Eric.
Please go ahead Sir.
Yeah.
Thank you operator, good afternoon, and welcome to Arlo Technologies 2022 third quarter financial results Conference call.
Joining us from the company are Mr. Matthew Mcrae CEO , Mr. Kurt Binder recently appointed 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 third quarter, along with guidance for the fourth quarter and full year provided by Curt well doesn't help time for any questions. If you have not received a copy of today's press release. Please visit <unk> Investor Relations website at Investor.
Dot com.
Before we begin the formal remarks, we advise you that todays 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 margin operating margins earnings per share tax rate expenses cash outlook guidance for the fourth quarter and full year of 2022.
Two of surfaces first business model.
The commercial launch and we'll launch new products and services strategic objectives and initiatives.
Market expansion and future growth the effect of our brand awareness campaign on our future growth.
Partnerships with various market leaders continued new product and service differentiation.
Supply chain challenges transportation costs, and the impact of COVID-19 pandemic.
<unk> 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 <unk> periodic filings with the SEC, including the most recent annual report on Form 10-K.
<unk> 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 Web site.
At this time I would now like to turn the call over to Matt.
Thank you Eric and thank you everyone for joining us today on <unk> 2022 third quarter earnings call amid.
Amid the rapidly shifting economic environment, the team executed well to produce a solid quarter of financial results. In Q3 total revenue was within guidance at $128 million up seven 7% sequentially and up more than 15% year over year and non-GAAP gross profit reached a record.
$38 million up over $13 million from a year ago. This resulted in a non-GAAP gross margin of nearly 30% in the quarter.
Our growing consumer SaaS business continues to be a key driver of our results total paid accounts were up 91% year over year as we added 195000 paid accounts in Q3.
Service revenue reached $35 4 million, which is up 31% year over year and our non-GAAP service gross margin rose to 66, 7%.
While we were pleased with our execution against the challenging supply picture near the end of Q3, we started to see a shift in consumer behavior, where broad based inflationary pressures coupled with the threat of recession are dampening consumer demand industry wide.
With a weaker demand outlook for our retail partners are moving to increase promotions and lower inventory.
In consideration of this we took immediate action to adjust our strategy and match our operational footprint to this new outlook for Q4 and 2023.
First we decided to pause our branding campaign.
As we discussed the initial awareness spend was a test implemented to measure via paid account uplift over our baseline subscriber run rate.
However, despite creating nearly 1 billion impressions in a promising lift in consideration in the first six weeks the volatility of the baseline in this market makes it difficult to effectively measure and evaluate the efficacy and ROI of the spend so the spend is paused indefinitely until we see the market returned to a more positive and stable trajectory.
Yeah.
Second we initiated a review of expenditures across the company to identify areas of further optimization of our business we.
We have well defined plans to lower run rate expenses in various areas of opex to ensure we are structured to maintain our most important levers of topline growth and achieve our long range plan in the most efficient and disciplined manner.
As these industry headwinds form we also expect overall component supply will increase giving us more leverage over supply chain pricing and allowing us to further utilize sea freight in the coming year to lower cost of goods sold.
Our goal is to proactively attack these opportunities to ensure they positively impact our business as soon as possible.
We are acting prudently and decisively to preserve capital during these headwinds and we will continue to adjust our operations as we deem necessary in the face of shifting data and consumer sentiment.
Despite the softening in consumer demand and the pause of our awareness campaign test Arlo remains on track to achieve the long range plan targets, we shared in March of this year.
In fact, the recent shifts in the economic environment proves out how important it is for arlo to continue diversifying our routes to market with enterprise partnerships to reach incremental households, as we shared in our long range plan.
Bearish or has installed arlo services in more than 320000 households through their direct channel in the last 12 months Calix continues to ramp through their broadband service provider partners and we continue to see success with our logo too with partners such as T Mobile Verizon U S cellular cellcom.
And Bell Canada.
We will continue to pursue these strategic partnerships as we make progress in diversifying our routes to market and creating predictable revenue streams.
<unk> focus on innovation and new product introduction rounds out the last focus area of our long range plan.
October we launched Arlo safe, our new mobile application and service that provides individuals and families safety and security on the go.
This represents a major expansion of our addressable market as Arlo has moved from protecting a specific location with hardware devices and services to protecting people no matter, where they are with our cloud connected app.
Our let's say it has numerous innovations, including a check and load for family members and direct dispatch at first responders to you or your remote family member.
Wireless safe is available for download now in the Apple and Google App stores and a two button service bundle is available now at best buy individual subscriptions are 499 per month, a family subscription is $9 99 per month, and we rolled out a new safe and secure plan, which combines the features of our arlo secure service for home.
Security with the Arlo say family service for $19 99 per month.
In addition to our let's say if I am pleased to announce two major product launches for our core arliss secure platform. The first is our innovative security system with the world's first multi sensor and utilizing secure link our new two way encrypted long range wireless protocol. This brings full sensor based security.
And professional monitoring to the Arlo ecosystem.
The modular hub includes battery backup cellular backup direct dispatch buttons and integrated motion sensor microphone for smoke carbon monoxide alarm listening and an NFC reader.
And our incredible multi sensor combines a door sensor window sensor tilt sensor motion sensor water leak sensor ambient light sensor temperature sensor tamper sensor and a smoke and carbon monoxide listener into one small form factor.
This brings significant advantages throughout our supply chain to our channel partners and to the end user experience.
Coupled with these groundbreaking hardware components, we launched our new 1999 safe and secure plan as mentioned, which includes $24 seven professional monitoring and cellular backup service.
The second product announcement is the new Arlo Pro five S. Smart security camera the profile of the <unk> marks a major advancement in the industry and integrates with our new security system to provide professional level features.
It is the world's first Tri band camera with dual band Wi Fi for maximum performance and Arlo secure link which provides new power modes for extended battery life increased robustness in challenging RF environments and continuous operation during power and internet outages by leveraging the battery and cellular back.
The functionality of our security hub.
This groundbreaking functionality creates what we believe is the world's most advanced and reliable security system.
Both the security system and profile of apps are available for preorder and we'll be shipping through channels in early December .
Our new channels and new products expand our addressable market and provides significant new avenues to expand our subscriber base and <unk> I am delighted to announce that <unk> now has more than one 7 million total paid accounts well on our way to our 5 million target.
And our annualized recurring revenue or <unk> continued to grow at a rapid pace exiting Q3 at $125 million up 56% year over year and marching towards our $300 million target.
And now I would like to introduce Kurt Binder, who recently took over as Chief Financial Officer for Arlo and also welcome him to his first call Kirk will provide more insight into our financial performance operational details and outlook for the fourth quarter and full year.
Thank you, Matt and thank you everyone for joining US today, let me start by saying that I am extremely excited to serve the company in my new role and I look forward to working with you all in the future.
I will start by sharing some financial details on Q3.
Revenue for the third quarter came in at $128 $2 million up nearly 8% sequentially and 15% year over year.
Against an uncertain macroeconomic backdrop and inflationary pressures impacting consumer spending we experienced softening demand in our customer base in the second half of Q3.
However, we are pleased that our channel diversification and our growth demonstrated resilience to deliver revenue within our guidance range.
Our service revenue for Q3, 2022 was another record $35 $4 million up 8% sequentially and 31% year over year.
This was driven by the addition of 195000 paid accounts in the quarter and a robust installed base of $1 7 million subscribers.
While service revenue accounted for only 28% of our Q3 2022 total revenue it represented 62% of our total gross profit.
Product revenue for Q3, 2022 was $92 $7 million, which was up 8% sequentially and 10% year over year.
Our year over year product revenue growth was driven by the shipment of one 3 million cameras worldwide with 45% of our revenue coming from our international customers.
Within our globally diverse customer base, we have experienced continued strength from our strategic relationship with various shore in the EMEA region with revenue up 70% year over year in that region.
Our ability to develop such a strong and collaborative relationship with bare shore has proven to be a great intangible for arlo and I'm excited to see what similar opportunities. We can develop in other regions across the globe.
From this point on my discussion will focus on non-GAAP numbers the.
The reconciliation from GAAP to non-GAAP figures is detailed in our earnings release distributed earlier today.
Our non-GAAP gross profit for the third quarter of 2022 was up $13 million or 52% year over year to $38 million.
This resulted in a non-GAAP gross margin of 29, 7% up from 29, 5% in Q2 2022.
And 22, 6% in Q3 of 2021.
The $13 million year over year increase in non-GAAP gross profit included $8 million from services.
And $5 million from products.
The improvement in non-GAAP service gross profit was driven by growth in our <unk>.
And the monetization of our installed base of paid subscribers coupled with cost optimizations.
The improvement of non-GAAP product gross profit was driven by higher product shipments and related revenue over a consistent fixed cost base.
non-GAAP service gross margin came in at 66, 7% significantly up from 59, 5% in Q3, 2021, and a slight improvement on 65, 8% in Q2 2022.
non-GAAP product gross margin was 15, 6% up from 10, 8% in Q3, 2021 and flat to Q2 2022.
Total non-GAAP operating expenses were 42, $3 million up $8 million or 24% sequentially and up $10 million or 30% year over year.
The increase in total non-GAAP operating expenses was driven by sales and marketing expense as we executed on the initial phase of our brand awareness campaign in which we invested a total of eight $8 million during Q3.
Although we experienced some immediate benefit from this campaign as Matt mentioned, we are pausing it until visibility into the current economic environment and our path to resuming profitability is clear.
Our total non-GAAP operating expenses, excluding the marketing investment were relatively consistent with the sequential and year over year periods.
And our head count at the end of Q3 was 360 employees, which was a slight increase from 354 in the prior quarter.
In Q3, we posted a non-GAAP net loss of $4 $2 million, which would have been non-GAAP net income of $4 6 million when excluding the brand awareness spend.
Our non-GAAP net loss translates to a net loss per dilutive share of <unk> <unk>.
Much better than our guidance and a <unk> <unk> improvement year over year.
The non-GAAP net loss figures were driven by a combination of revenue growth and gross margin expansion, coupled with a disciplined approach to cost management.
You can expect us to continue a deliberate and disciplined approach to managing operating expenses.
As Matt mentioned earlier, our plan to reduce operating expenses in areas such as head count office leases and outside services is prudent, especially in this uncertain economic climate, but we will remain steadfast in driving revenue growth and profitability through paid subscriber adds and supplemental service opportunities.
Regarding our balance sheet and liquidity position, we ended the quarter with 125 $3 million in available cash cash equivalents and short term investments down $10 million sequentially and $41 million year over year.
The reduction in available cash this quarter is attributable to fluctuations in working capital principally an increased investment in inventory.
Our Q3 inventory balance was $73 $2 million an increase.
<unk> of $34 million over Q2, 2022 with inventory turns at four three times as compared to seven five times last quarter and seven six times a year ago.
The increase in inventory is attributable to a number of factors, including the seasonal restocking in anticipation of the holiday consumer purchasing pattern.
Coupled with our internal objective to maintain more appropriate inventory levels to support consumer demand in the fourth quarter and early 2023 or.
Our inventory balance in the past quarters was low due to supply chain constraints experienced by arlo as well as many other companies.
The objective is to maintain a more healthy inventory level. So we are responsive to consumer buying patterns, but in an efficient and cost effective manner.
And finally, our Dsos came in at 59 days down from 62 days, a year ago and up from 57 days sequentially.
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.
We expect fourth quarter revenue to be in the range of $105 million to $115 million.
We expect our GAAP net loss per diluted share to be between 30.
And 23 per share and.
And our non-GAAP net loss per diluted share to be between 13.
And <unk> <unk> per share.
Our Q4 guidance takes into account approximately $5 million of residual brand awareness spend committed before we pause the overall campaign, considering the uncertain economic climate and potential near term topline revenue headwinds Arlo is committed to a disciplined approach to expense management and streamlining <unk>.
Operations.
As discussed earlier, we plan to reduce our costs beginning in the fourth quarter, which would include reducing our global workforce by about 10% in order to drive the business to a breakeven non-GAAP operating income target. We are acting quickly and expect that our cost savings initiatives will begin to manifest in Q4 and will be fully.
<unk> actualized in the second half of 2023.
Further we expect to end the year with available cash cash equivalents and short term investments in the range of $90 million to $100 million.
While this is lower than previously forecasted we believe this range represents an acceptable level for cash as the working capital investments materialized in the first half of 2023, and we drive closer to non-GAAP operating income.
We will continue to monitor our performance and prudently manage our operations to preserve our cash position.
As we evaluate the upcoming 2023 year, we expect to experience volatility in the market for the next few quarters.
In General we believe we are now facing a market that will be flat to down in the upcoming quarters and we have rapidly pivoted our strategy and operations to address this environment.
Although we expect to grow a bit faster than the market, we will manage our spend in 2023 to reflect market conditions, but in a manner that allows us to return to a breakeven non-GAAP operating income target by the back half of 2023.
And now I'll open it up for questions.
Okay.
And at this time I would like to remind everyone in order to ask a question. Please press star and then the number one on your telephone keypad.
I'll, let you compile the Q&A roster.
And our first question will come from the line of Ahmed Chris on with Gws financial.
Please go ahead Sir.
Hi.
Talk about the actions you're taking are you taking it from.
Head Count perspective are you taking out from having.
Having already stocked inventory.
Source expensive components right now.
Could you just be a little bit more elaborate on that.
Yes.
Part of it is part of the reviewing the operations as I would say its comprehensive across the organization. So.
Curt mentioned, an overall reduction in head count of about 10% across the company and Thats an action that's already been taken.
We have a full review of outside expenses. So we're going to look to reduce expenses from kind of outside parties and outside services I would tell you as part of the.
Analysis, we are seeing as well I think theres a lot of operational savings that are happening is these headwinds for them. So we're seeing obviously freight.
<unk> has come down as part of Cogs were seeing component supplier, obviously start to get more.
Come off of restrictions and the ability to negotiate pricing as we go forward as well so it's everything from supply chain costs cost of goods sold to actual operational both internal and external expenses of the company.
And why do you think it sounds like.
You were caught off guard. So why do you think that's the case.
It was it really just consumer driven or was this just retailers just.
Across the board.
Cutting them out of inventory.
Yes, I don't think were caught off guard I think we were watching it very carefully if you look at our commentary in the last quarter. We said there is there is demand we are watching demand on a weekly basis. In fact, we will look at what's coming in from our from our channel.
On a twice weekly basis, and I will give you the detail in the quarter. The first half to even even maybe two thirds of the quarter were actually strong and you can see that in our results of Q3 and it wasn't until after labor day.
We saw some of the data and the signaling from our retailers to your point the retail partners kind of across the board.
Not only were they seeing different demand profile and customer sentiment.
But they were changing their operations on how much inventory they want to hold and we've seen some summit retailers just give you an idea moving from the kind of normal range of 12% to 15 weeks of inventory that they would hold down to as low as $4 six weeks of inventory.
They want to hold as they go through this holiday period. So there was some abrupt changes out there after labor day, and we reacted very quickly and I'll tell you after that labor day week, we collected that data is when we started adjusting some of the operations in the company.
And my last question is.
Pausing the AD spend and cutting head count why are you expecting net losses to continue through the first half of 'twenty three given that subscriber.
<unk> revenue is going up.
Previously you had been talking about there sure adding to your service revenue as well through there.
Rollout of their cameras.
Okay, well I think in terms of our guidance.
Our direction for 2023, our overall feeling is we want to make sure that we're a bit cautious we believe that the plan that we've laid out and the actions that were in the process of taking will get us to a point where we're at.
You breakeven and non-GAAP .
Operating target profit target, but.
And our hope is is that certain things will start to unfold here in probably Q1 to Q2 to get us a bit to that level earlier, but we thought it was best to be a bit cautious given the uncertainty in the economic climate that we're dealing with right now.
Okay alright, thank you.
And again its star one if you would like to ask a question. Our next question will come from Jacob <unk> with Lake Street capital markets.
Please go ahead.
Yeah, Hey, guys. Thanks for taking my questions.
Can you just confirm the guide for 'twenty three.
Previously it was doubling the growth rate.
<unk> income positives.
Is that on a quarterly basis or are you kind of engine after the year.
Well I think.
That was assuming that the brand spend obviously continued into next year and so when we look at the market kind of going into next year, we're seeing.
We're assuming that the current.
Environment is going to continue into next year and that the market, meaning our segment, but also the overall market.
Our entire product segment is going to be flat to down and Thats what were seeing.
From from the channel perspective, and the early data that we're seeing on what they think is going to continue after the holiday period.
Curt mentioned in his remarks said, we always expect to do a bit better than that so we are hoping to grow a little bit year over year as we go through and then you would see the normal seasonality as we exit this year.
And then going into next year. So I would say, that's obviously pausing the brand spend and seeing what's happening in Q4 and thinking that's going to continue at least into the first half of next year from a customer sentiment perspective gives you a bit of an update on what we think is going to happen next year.
Okay. That's helpful.
Maybe just talk about.
The increase in inventories.
Where is the softness in the U S.
The fourth quarter of <unk>.
And the fourth consecutive quarter of <unk>.
Shipments of bearish over $50 million, but.
Maybe just talk about where youre seeing the softness in the U S is it on the retailer side or.
Our customers now come into Arlo dot com as much.
Yes, I would say that if you.
A look at it from a demand perspective, it's definitely in the consumer retail channels is where were seeing and thats part of our commentary is around our diversified re.
Revenue basis is really helpful and that we have this big services business, which is our primary strategy as a company and provides that foundation and an engine room for the company.
Partners like <unk>, obviously are very strong for us where we're seeing that weakness is really through the retail channel partners on.
On the consumer side, yes.
Yes, and just to add to that I mean, we made an investment in leading into the fourth quarter about $34 million of incremental inventory.
And in the midst of that as Matt mentioned earlier that there was a bit of this shift in expectation with the retailers on the weeks on hand inventory that they plan to hold especially in the club channel.
We have.
<unk> adjusted to that but what that has resulted in is a bit of destocking that occurred in Q3, probably will continue into Q4 and that is impacting.
Some of the revenue targets. So on the investment we think inventory is going to pay off over the next couple of quarters, mainly because we think we'll be at levels, where we will be able to meet consumer demand a bit quicker.
And also because we are trying to find ways to reduce the overall cogs associated with logistics and freight and getting inventory here into the Dcs and into our retailers.
Okay.
Maybe just one last one on brand awareness.
Can you.
Give us a more specific timeline on when you may have paused that campaign and.
Maybe just talk about the burn rate on the.
The increased AD spend give us a better.
Don.
Sales and marketing expense.
Yes.
When we started getting the signals towards the end of Q3, that's when we made the decision to pause the spend there is a bit of a lag because you buy the media a bit ahead of time for that so the spend has been stopped.
As we talked about you'll see a little bit of a residual in Q4, but after that youll see nothing from that brand awareness campaign as we go forward again, we saw some great initial results. It only ran for about six or seven weeks, but we had over 1 billion impressions and had a huge amount of kind of <unk>.
Access to the demographics that we were targeting over 80% reach and some of those key categories and we're just starting to see flow through but.
We think at this time despite their early success there given that one of the primary.
Reasons for doing this was to judge lift over our baseline and now that the baseline has changed.
And the customer sentiment has changed we feel it's the right thing to do is to stop that until until.
Until the market kind of.
<unk> gets more stable and starts to go on a more positive direction. So stop it towards the end of Q3.
Our two after labor day, Youll see some residual spend because again the purchases of some of that media happens months months and months earlier and then it will tail off as we get into next year I'll go back basically down to zero.
Alright, thanks, guys.
Yes.
And with no further questions I'd like to turn the call back over to Mr. Matthew Mcrae CEO .
Thank you operator.
I would like to take a moment to thank all the teams that are left for the hard work to deliver such outstanding results in the face of continuing pandemic and macroeconomic headwinds, while we could not predict the current customer spend environment. We when we developed our long range plan, our diversified revenue base innovation leadership, coupled with our expense reduction plan.
<unk> and disciplined execution means our confidence in achieving those long range targets is unchanged.
Thank you everyone for joining us today.
And that will conclude today's conference. Thank you for your participation and you may now disconnect.
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