Q4 2022 Arlo Technologies Inc Earnings Call
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 at that time. If you have a question you will need to press the star one on your push button phone.
I would now like to turn the conference over to Eric violent. Please go ahead Sir.
Thank you operator, good afternoon, and welcome to Arlo technologies fourth quarter and full year of 2022 financial results Conference call.
Joining us from the company are Mr. Matthew Mcrae CEO , Mr. Kurt <unk> CFO .
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 fourth quarter and full year, along with guidance for the first quarter and full year provided by Kurt.
Well then have time for any questions.
If you've not received the copy of todays release, please visit <unk> Investor Relations website at Investor Although dotcom.
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 margins operating margins earnings per share tax rates expenses cash outlook guidance for the first quarter and full year 2023.
Transition to a service first business model, the commercial launch and momentum with new products and services.
Strategic objectives and initiatives.
Market expansion and future growth.
Of our brand awareness campaign on future growth.
Partnerships with various market leaders.
<unk>, new product and service differentiation supply chain challenges transportation costs.
And the impact of the 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 <unk> periodic filings with the SEC.
Including the most recent annual report on Form 10-K.
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.
Thank you Eric and thank you everyone for joining us today on <unk> fourth quarter and full year 2022 earnings call.
Despite softening consumer demand and tightening retail inventory levels are low delivered a solid fourth quarter with both revenue and non-GAAP net loss per share above the high end of our guidance.
Revenue was $118 $5 million.
Which was down year over year, but non-GAAP gross profit rose 2% year over year.
Our strong pace of subscriber growth continued with arlo, adding over 189000 paid accounts in the quarter.
This fueled our annual recurring revenue growth, which was up 53% year over year to $138 million and non-GAAP service gross margin reached 70%.
Both records for Arlo.
Looking across 2022, you see the results of a cohesive team delivering stellar execution.
Although produced total revenue for the full year of $494 million.
A 13% year over year and within the range of the guidance, we provided at our analyst day a year ago.
Our service revenue was up more than 30% to $136 5 million.
While our service costs were up less than 10% exhibiting the leverage that drove a seven percentage point increase in service gross margin to 67%.
And if you remove our discretionary marketing spend arlo delivered four quarters of non-GAAP operating profit in 2022.
And I am thrilled to announce that our level surpassed 2 million paid accounts next week more than doubling our subscriber base over the last five quarters.
This is another massive milestone for the company and proves that disciplined execution, even when facing external headwinds can produce impactful results.
Despite that impact the full value of our services business is not widely understood.
Clear when looking at total service revenue and our annual recurring revenue or <unk>.
So service business is growing at roughly 50% year over year have 70% gross margins and we expect the next 12 months of service revenue to be nearly $200 million.
Let me repeat that Arlo service business is growing at roughly 50% year over year have 70% gross margins and should grow 45% plus to reach nearly $200 million in.
In 2023.
These numbers illustrate the current valuation dislocation and the immense upside at ARVO.
Driven by our services business are those expected to crossover to non-GAAP profitability in Q2 of this year and to reach full year non-GAAP operating margin of nearly 5% for 2023.
These metrics are substantially ahead of expectations and further validate the power of <unk> Services' first transformation to generate outstanding shareholder value.
From a technology perspective, Arlo continues to win on innovation and experience.
<unk> was recognized as quote unquote, the Apple of smart cameras by T. Three and the quote unquote connected home company of the year by the Iot Breakthrough Awards.
Our cameras won numerous awards in 2022, including I mentioned in time magazine's quote unquote best inventions of 2022 and have already won best of 2023 Awards for our men's Health Tech Tech High review Dot Com digital trends and multiple awards from CNET, and a smart camera and doorbell.
El categories.
<unk> also expanded our offering to include a powerful security system with 24, seven professional monitoring featuring a truly innovative all in one sensor that provides significant advantages for users and channel partners.
<unk> allows arlo to directly address the broader global home security market, which is roughly $50 billion.
And we will grow to nearly $80 billion by the end of 2025.
There are more than 20 million households in the United States alone that are stuck on old security systems with antiquated technology from traditional providers are low now has a full security solution took directly replace that functionality significantly upgrade the capabilities and substantially improve the user experience we are <unk>.
Rolling out the Arlo security system across our retail and direct channels now and we'll be leveraging partnerships to drive additional awareness and distribution.
In addition to the security system launch Arlo closely analyze the latest market data supply chain information and consumer behavior in our existing channels.
We believe a more aggressive customer acquisition strategy, coupled with our best in class service metrics can drive additional shareholder value as we look to accelerate paid accounts in 2023.
Although we will focus on lowering the barrier of entry into our ecosystem by bringing down initial purchase prices and exploring new sales models at the same time <unk> is upgrading our service peers, introducing new annual service plans and raising subscription service pricing.
And to further drive this effort today, we announced a strategic partnership with citizens bank to provide user financing for purchases of <unk> solutions. The citizens pay platform will enable arlo to bundle hardware and service into a single low monthly price opening a path to directly address.
Those 20 plus million traditional security household with a more innovative and cost effective solution.
The platform is used by companies such as Apple and Microsoft to create compelling offers with low barriers of entry across both direct and retail channels.
<unk> looks to leverage this unique sales model and partnership to acquire incremental paid accounts and new market segments, where users preferred not to pay for the system upfront.
The first offers will rollout in the second half of this year.
As you look to our 2023 guidance you will see a rebalancing of wireless pricing model that will accelerate growth increased service revenue and allow arlo to address a wider market segment than ever before as we trade our hardware revenue and hardware margin for incremental new paid accounts and higher service margin and do.
The scale of our services business It will drive demonstrably greater profit to arlo as a whole.
At this time I will hand, the call over to Kirk, who will provide more insight into our financial performance operational details and outlook for the first quarter and full year.
Thank you, Matt and thank you everyone for joining us today.
As Matt mentioned 2022 was a transformative year for <unk> with our services first strategy, leading to continually improving performance in our services business.
We have not only seen consistent paid account additions, but continued best in class subscriber retention and margin expansion.
Now I will start by sharing some financial details on Q4, and the 2022 full year.
Revenue for the fourth quarter came in above the high end of our guidance range at $118 $5 million, but down 8% sequentially and 17% year over year.
As mentioned last quarter and consistent with commentary heard across the broader consumer retail market, we experienced softening demand in the second half of Q3, which continued into the fourth quarter.
This trend coupled with certain retailers tightening their inventory level can be attributed to the revenue decline we experienced in Q4 and we expect these pressures to continue into early 2023 revenue for the full year 2022 was 490 <unk>.
$4 million up.
Nearly 13% year over year and within our original annual guidance range.
We were pleased that our channel diversification and our growth demonstrated resilience to deliver revenue within our guidance range.
Our strategic shift to a services first operating model was instrumental in driving our year end.
Our two $137 8 million up 53% year over year, and thereby providing greater predictability and visibility into our ability to deliver near term revenue and profitability targets.
Our service revenue for Q4 was another record at $38 3 million, an increase of $9 9 million or <unk>, 35% year over year, and an increase of two $9 million or 8% quarter over quarter driven by the addition of 100.
89000 paid accounts in the quarter.
Our service revenue for the full year 2022 was $136 5 million.
An increase of $33 million or 32% year over year, driven by the addition of 795000 paid accounts in the year and a robust installed base of $1 9 million subscribers at the year end.
While services revenue accounted for only 28% of our 2022 revenue it represented 67% of our total gross profit.
Product revenue for Q4 was $80 2 million, which was down 14% sequentially and 30% year over year.
Our product revenue for the full year 2022 was $353 9 million, an increase of $22 3 million or 7% year over year.
Our 2022 year over year product revenue growth was driven by the total $4 5 million cameras shipped worldwide with 45% of our revenue coming from our international customers.
Within our globally diverse customer base, we experienced solid growth for the full year from our strategic relationship with very short in EMEA with revenue up 46% year over year.
Our ability to develop such a strong and collaborative relationship with bare shore has proven to be a great intangible for arlo.
From this point on my discussion points will focus on non-GAAP numbers. The reconciliation from GAAP to non-GAAP figures as detailed in our earnings release distributed earlier today.
Our non-GAAP gross profit for the fourth quarter was $33 $2 million up slightly year over year.
This resulted in non-GAAP gross margin of 28% up 500 basis points from 23% in Q4 2021.
Our non-GAAP gross profit for the full year 2022 was $140 9 million up $28 9 million or 26% year over year.
This resulted in a non-GAAP gross margin of 29% up 300 basis points from 26% in 2021.
The $28 $9 million year over year increase in non-GAAP gross profit was attributable to the growth in our services business the.
The improvement in non-GAAP service gross profit was driven by growth in our IRR and the monetization of our installed base of paid subscribers coupled with cost optimization.
non-GAAP service gross margin for the full year was 67% significantly up from 60% in 2021.
non-GAAP product gross margin for the full year was 14% and consistent with 15% product gross margin in 2021.
We are proud to say that during 2022, we delivered four consecutive quarters of margin growth in our services business.
Total non-GAAP operating expenses for the fourth quarter were $37 1 million.
Down $5 $2 million, or 12% sequentially and up $7 $9 million or 27% year over year.
The non-GAAP operating expenses for the fourth quarter were in line with expectations and reflect the cost savings initiatives implemented in Q4.
Total non-GAAP operating expenses for the full year 2022 were $146 9 million up $23 $8 million or 19% year over year.
The increase in total non-GAAP operating expenses year over year was principally driven by marketing expense as we executed on the initial phase of our brand awareness campaign in which we invested a total of $15 $6 million during the year.
As indicated last quarter, we are pausing the campaign until visibility into the current economic environment is clear.
Our total non-GAAP operating expenses, excluding the marketing investment were relatively consistent with the prior year period.
Our head count at the end of Q4 was approximately 340 employees, which represents a decrease from about 360 team members at the end of Q3 and 350 team members in the prior year end.
In Q4, we posted a non-GAAP net loss of $3.6 million, which would have been non-GAAP net income of $1 $6 million when.
<unk> the brand awareness spend.
Our non-GAAP net loss translates to a net loss per diluted share of <unk> <unk>.
Much better than our Q4 guidance of a net loss per diluted share of <unk>.
For the full year 2022, we recorded a non-GAAP net loss of $5 9 million.
Which would have been non-GAAP net income of $9 8 million when excluding the brand awareness spend.
Additionally, we would have been profitable on a non-GAAP basis, each quarter of 2022, if we exclude the brand awareness expense.
Our non-GAAP net loss translates to a net loss per diluted share of seven <unk>.
Much better than our full year guidance of a net loss per diluted share of <unk> 12.
And a remarkable improvement year over year.
The improvement in our non-GAAP net loss 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 be deliberate and disciplined with 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 in areas, such as head count office leases and outside services.
These initiatives have proven to be prudent and effective considering the uncertain economic climate, but more so in aligning our organizational structure with the services' first strategy as we drive revenue and profitability through paid subscriber additions and supplemental revenue service opportunities.
Regarding our balance sheet and liquidity position, we ended the quarter with $113 $7 million in available cash cash equivalents and short term investments.
This balance was down 11, 5 million sequentially and $62 million year over year, but as well above the high end of our guidance range provided last quarter.
The overall reduction in available cash is attributable to the funding of our ongoing operations as well as customary fluctuations in working capital.
At the end of Q3, we have bolstered our inventory balance to $73 $2 million in order to meet anticipated consumer demand in the fourth quarter and beyond while also taking advantage of reduced supply chain and freight costs.
We are pleased that our Q4 inventory balance ended at $46 6 million.
Representing a decrease of $26 7 million or 36% from Q3 2022 with inventory turns at six four times as compared to four three times last quarter.
The decrease in inventory is attributable to an exceptional focus on supply chain efficiency and working capital management, coupled with other factors, including our internal objective to maintain more appropriate inventory levels to support consumer demand throughout 2023.
Our objective is to maintain a healthy inventory level. So we are responsive to consumer buying patterns, but in a capital and cost efficient manner.
And finally, our accounts receivable balance was $66 million as of December 31.
With Q4, Dsos at 50 days down from 59 days sequentially and consistent with the prior year period end.
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 will surpass the 2 million subscriber milestone next week. We believe the company is upon an inflection point in 2023.
The forecasted revenue growth in our services business will drive our LOE to be materially profitable. This upcoming year, specifically, we expect our gross profit from services alone to exceed our operating expenses, thereby thereby making us profitable at the operating income line by the end of Q2.
Given the current consumer environment, we remain cautious about our product revenue outlook for the year.
As Matt alluded to we are going to adjust our hardware or product sales levers as necessary to drive new household formations and fuel further subscriber growth.
We'll remain responsive to sudden market shifts and prioritize the revenue growth and profitability of our services business.
With that said, we expect the first quarter revenue for 2023 to be in the range of $100 million to $110 million we.
We expect our GAAP net loss per diluted share to be between 23.
And 17.
And our non-GAAP net loss per diluted share to be between seven <unk> and.
<unk> per share.
Our Q1 2023 guidance takes into account approximately $600000 of residual brand awareness spend committed before we pause the overall campaign.
For the 2023 full year, we expect revenue to be in the range of $460 million to $490 million factoring in our cautious outlook for product sales potential headwinds in the European region and heightened the level of optimism.
And visibility for growth in our service business.
Service revenue is forecasted to grow at roughly 45% year over year, thereby becoming a much larger portion of our overall revenue and profitability mix.
In terms of seasonality, we expect approximately 40% of our 2023 revenue will be in the first half of year.
We estimate non-GAAP product gross margin will be in the mid single digits 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% as we exit 2023.
non-GAAP operating expenses are expected to come in at approximately $150 million for the year.
Further we expect to maintain our available cash cash equivalents and short term investments at or above $100 million throughout the year.
We believe this represents an acceptable level of cash to operate the business as we drive closer to sustainable non-GAAP operating income and increasing free cash flow generation. Additionally, we expect our cash level to be on an upward trajectory as we exit 2023.
And now I'll open it up for questions.
At this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad.
Pause for just a moment to compile the Q&A roster.
Your first question comes from the line of Jacob Stephan with Lake Street Capital. Your line is now open.
Yeah, Hey, guys congrats on the quarter.
Maybe just starting out could you talk about the.
Kind of the home security market in general.
What kind of trends are you seeing with your consumer channels Youre best Buy's Costco's.
And then maybe contrast that with kind of the strategic partners.
Yeah, absolutely. Thanks for the thanks for the congrats on the quarter, we feel really proud of what was accomplished in our outlook for the year from a from a trend perspective, what I can tell you is we saw towards the end of Q4 definitely some resilience in the security market from especially from the consumer.
And the normal consumer channels that you've mentioned in that that continues into Q1 and you see that reflected in the guidance.
I would say thats true across channels. So we.
We don't we haven't seen the demand really drive across strategics or the retail channels for the most part we do think there might be a little bit more softness coming from Europe over time and that was reflected in some of curt's comments, just because of the macroeconomic situation there vis vis.
The states, but overall I would say.
We're seeing some resilience in the demand for home security, but also <unk> in particular, and that's reflected not only in our quarter results, but in the guidance that you see us articulate and going forward.
Okay.
So maybe just focusing on.
Kind of inventory levels and gross margins in Q4 here.
What's kind of the margin.
Decrease.
The result of the sales you guys are running order.
Guess, what kind of levels of margin pressure there.
Well I think on the product or hardware margin side we.
We're ensuring that we recovered from a overall channel inventory level, we wanted to make sure that.
As we get into 2023, we felt good about where our inventory levels were not just on hand for ourselves, but also with our.
Our retail partners and I think that showed in the.
Product gross margin, we were extremely pleased with the outcome on the services gross margin.
We saw that actually exceed our expectations and the beauty of that is is that we see that going into the first part of 2023 and trending up as we mentioned in the in the guidance I think if you look at 2023.
We do believe that we can be very promotional and on the hardware side and we expect to do that.
Our goal really is to continue to drive household formations and subscriber growth.
Super exciting news about us achieving the 2 million subscriber mark this upcoming week so thats.
That's super exciting in and of course, we wanted to remain focused on our overall operating profitability and as we indicated or Matt had suggested we're targeting about 5% operating margin coming out of 2023, so although the.
The hardware product gross margin might be a bit under what was expected in Q4, we think that that'll be a key lever going into 2023 to help us drive the new household formations and incremental subscriber growth.
Okay got it yeah 2 million paid subs a certain layer.
An excellent milestone maybe just one last one.
When looking at the new security system launch.
Early comments you guys can make on kind of what youre seeing.
Yes.
We've got it in a couple of channels now youll see the rollout as we mentioned in the prepared remarks grow not only in additional retail locations, but probably with.
Our strategic partner too as we go through this year initial feedback has been has been great.
Look at some of the reviews Theyre, all kind of $4 95 on some of our retail accounts.
We're taking a lot of feedback in as well and making very quick iterations and so the products getting better and better by the week.
And we're looking forward to actually.
Distributing it on a kind of a broader basis I would tell you most of our customers right now are existing arlo customers and that's on purpose, we're really mining our existing customer base as the initial target audience and then we'll see that grow as we broaden distribution through the spring and going through the rest of this year.
Okay got it that's helpful. Thank you.
Youre welcome.
Your next question comes from the line of Jake Nordson with Raymond James Your line is now open.
Hey, guys I appreciate you taking my call.
I just wanted to dive a little deeper on services and product mix.
Any comments on what happened throughout the quarter and how should we think about that mix going forward.
Yes sure.
<unk>.
When you look at mix.
For 2022, and <unk> four we were trending in sort of that 20% to 30% of our revenue coming from services and in a <unk>, 70% coming from product.
That was in line with our expectations and obviously that mix plays into our overall gross margin.
Performance I think as you look at 2023, and we move throughout 2020, there is going to be a considerable uplift in the services revenue and especially as a as a portion of the overall total revenue we would expect that the mix would shift from say that 30% to probably hire maybe exceeding 48 into the 45%.
Range of total revenue services in that say, 40%, 45% hardware product in that say, 60%, 65% range, that's going to have a considerable impact on our overall gross margin and obviously an impact on our overall operating profit and that's a big part of our overall strategy because as we mentioned before and are driving this.
Fiber base getting.
<unk> up and <unk>.
And really targeting cost optimization to drive that margin expansion is really really important for us.
Awesome and then last one from me can you just provide any metrics around the growth of our luck safe what are you seeing there in terms of customers outside the arlo ecosystem choosing safe as their entry point to our LOE just any color there would be helpful.
Yes, its arlo space actually very exciting.
Product for Us and I say product is really a service and what's interesting is it's the first service from Arlo, where you do not have to buy a piece of hardware.
Actually come in and so it's.
A simple app store download gets you into arlo safe. So that's one two.
We've chosen to actually bundle it and are in a higher priced tier so and are now $25 pricing per month tier includes arlo secure which is the professional monitoring for all of our cameras, a security system and Arlo safe.
And it's a little early to provide some metrics that Kurt just alluded to some <unk> increase we're hoping by next quarter, we could share some actual numbers on that but I would say early indications are positive on both arlo safe and the bundle, which is what we call our safe and secure bundle and we think it's a really important strategic asset to bring <unk>.
From protecting a location with its hardware and Arlo secure service to actually protecting families and individuals on the go and it's resonating quite well I do believe also.
That youll see some some action in some verticals.
With that space as far as Arlo safe over time as well. So we think there is some deep partnership opportunities that will provide some additional upside as we get through 2023.
Perfect. Thank you so much.
Welcome.
Your next question comes from the line of Matt.
Matt Chris on with Dws. Your line is now open.
Could you just talk about the.
Customer demographics.
Household you're now targeting with the approach of having lower price point on the hardware.
How sticky are they too just continues to pay for that.
Subscription monthly subscription.
Yes, it's something we've looked at quite a bit and if when you looked at that market data a couple of years ago.
Some of the very low price point, it's not that we will hit some.
The price points in this range had a relatively low attach rate on service.
Part of the prepared remarks, we talked about looking at the latest market data.
As we on promotion has hit some relatively low price points through Q4 for holiday promotions, we are seeing.
Very consistent attach rates on service now at these lower price points. So what we're seeing is consumers.
Being able to buy lower priced hardware is not reflecting in a much lower attach rate on service and that's a relative change since we originally spun from next year and took a look at the market.
You know call. It three years ago. So what we're expecting is might be a little bit lower but a relatively consistent level of both attach rates and churn at some of the new price points will hit and of course, a broader market from a demographic perspective.
Especially as we're looking at some of the retail headwinds from pricing and things that we're seeing in the market just from a just from an overall economic perspective. So some of the information we've seen in Q4 has led us to.
Look at some of the rebalancing of the hardware price points versus the service price points and so what you've seen US do is lower some entry point pricing for some of our hardware and we've actually increased service pricing on a monthly basis and that rebalancing is part of what's leading into the big boost in profitability that were forecasting for 2023.
<unk>.
Okay, and then a year ago, you had been talking about how the consumer is not really aware of your brand now.
For the year, you were talking about pricing capturing.
It sounds like market share is this coming because of the price points or is this coming because of your competitor having.
Issues.
For management changes and pricing issues as well.
Yes, I would say, it's mostly coming from.
A change in consumer behavior and tapping into that change.
Especially in Q4, and what we saw in Q4.
Some of our competitors are going through some changes and the like and I'm sure that has an impact as well, but a lot of it is us rebalancing our strategy against what we're seeing in the market. What we're seeing from a consumer perspective and some of this is a natural transition that you see when a market goes from what I'll call early adopter to become.
More of the early part of the mass market, where if you can bring down at the right time as some of those entry price points still get them subscribed and have that long term relationship you start to tap into to a broader market and where we saw the beginning of that in Q4, and that's something we're going to continue to do in 2023.
Okay, great. Thank you.
Youre welcome.
There are no further questions at this time, Matt I'll turn the call back over to you.
Thank you operator.
<unk> has a proven track record of executing through hardship and headwinds from shifting consumer demand to a global pandemic, our discipline focus and continued optimization of our business has created a services first company, serving nearly 2 million subscribers and rapidly driving to profitability.
Looking ahead, the journey from 2 million to 3 million subscribers will be just as transformative and impactful to our business. We look forward to keeping you up to date and thank you everyone for joining us on the call today.
This concludes today's conference call you may now disconnect.
Okay.
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Okay.
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Yes.
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