Q2 2023 Arlo Technologies Inc Earnings Call
Ladies and gentlemen, thank you for standing by.
At this point 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 a button phone.
I would now like to turn the conference over to Eric violin. Please.
Please go ahead Sir.
Thank you operator, good afternoon, and welcome to Arlo technologies second quarter 2023 financial results Conference call.
Joining us from the company are Mr. Matthew Mcrae, CEO and Mr. Kurt Binder 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 second quarter, along with guidance for the third quarter and full year provided by Kurt.
Then have time for any questions.
Not received a copy of todays release, please visit our Investor Relations website at Investor <unk> 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 margins operating margins earnings per share expenses cash outlook free cash flow and free cash flow margin.
Guidance for the third quarter and full year of 2023.
And timing of paid subscriber growth.
The transition to our services first business model.
Commercial watch and momentum of new products and services.
Strategic objectives and initiatives.
Market expansion and future growth.
The effect of our brand awareness campaign, our future growth.
Partnerships with various market leaders and our 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 <unk> 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.
Thank you Eric and thank you everyone for joining us today on <unk> second quarter 2023 earnings call.
<unk> has completed the transformation to a service business as evidenced by the underlying drivers of our outstanding financial performance paid.
Paid accounts grew 55% year over year to 2.3 million subscribers service revenue grew 54% year over year, reaching a record $50 million and our annual recurring revenue grew 66% year over year to 100.
$94 million.
We also achieved a record service gross margin of 75%.
All of these metrics are substantially ahead of where we hope to be when we rolled out our long range plan, a little more than a year ago.
This service acceleration is partially attributable to the pricing strategy Arlo implemented in Q4, where we brought down hardware pricing and raised subscription service pricing.
While this rebalancing of value reduces product revenue and gross margin it generates incremental product demand by lowering the barrier of entry for the Arlo solution and substantially increase of service revenue with no material impact on churn.
This any elasticity in the search subscription pricing is a true testament to the value our services provide our customers.
Diving in a bit deeper average revenue per user for retail and direct paid accounts is up roughly 24% when compared to a year ago.
This in turn has pushed the lifetime value of our retail and direct paid account over $700, what's more even though the current number of small households that have the new Arlo security system show in <unk> that is an additional 60% higher which highlights a clear app.
To drive <unk> up over time.
This services performance and the excellent execution by the Arlo team drove our overall results for the quarter.
Revenue came in at $115 1 million.
Which was at the top end of our guidance and we delivered a record non-GAAP earnings per share of <unk>.
<unk> achieved a record company gross margin of 37% and record operating margin of 5%.
And with Great working capital management, Arlo produced 10% free cash flow margin.
Comparing the first half of 2023 with the first half of 2022 Arlo improved its cash from operating activities by $52 million and for the first time in company history. Our non-GAAP gross profit from services alone exceeded our non-GAAP operating expenses. This is a huge.
Huge crossover point for Arlo and highlights the exciting trajectory we're on.
Our strategy and execution are driving these results and generating significant shareholder value.
Fight the macroeconomic conditions, we are seeing strong demand as is evidenced by our key metrics and our inventory levels. Most recently, we saw that demand carry through to a successful prime day, which gives us a glimpse into the current consumer mindset ahead of the second half.
This upcoming holiday season, our level of lean further into our successful pricing strategy by launching a totally new low cost security camera platform and we have secured substantial placement and promotional vehicles across our major channels.
Customer acquisition drives paid accounts, which drives the expansion of <unk> profitability.
With this backdrop, we expect full year service revenues to grow nearly 50% year over year and now exceed our $200 million target.
Our non-GAAP service gross margin for the full year will be roughly 75% and should propel us to our target of 5% non-GAAP operating margin for the full year of more than six percentage point improvement compared to 2022.
It is an exciting time at <unk> as we witnessed the years of hard work begin to materialize in a meaningful way across the business congratulations and thank you to the whole arlo team for the milestones we passed and the ones. We are focused on next.
And with that I'll turn it over to Kurt.
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 Q2 2023.
Revenue for the second quarter came in at the top end of our guidance at $115 1 million roughly flat sequentially and slightly down year over year.
While revenue was relatively consistent year over year the.
The composition of that revenue changed dramatically.
In the most recent quarter service revenue was 44% of total revenue while last year. It only accounted for 28% of the total revenue.
This shift is reflective of our services first strategy as well as our new pricing strategy.
We are extremely pleased with our services revenue and our growth, which helped deliver revenue at the top end of our guidance range and contributed to our low generating non-GAAP operating profit in Q2.
$5.4 million or 5% operating margin.
And 11 $5 million in free cash flow or 10% free cash flow margin.
Our service revenue for Q2 was another record at $53 million, an increase of $17 5 million or 53% year over year, and an increase of $6 4 million or 15% quarter over quarter.
This growth was driven by our subscription price increases and the addition of 245000 paid accounts in the quarter.
This number reflects a catch up in the number of paid accounts in our European region, which was being underreported by various sure in previous quarters.
Our normal net paid account run rate remained in the 170000 to 190000 range.
While we expect this catch up to continue over the next couple of quarters as various sure works through their system correction.
This does not impact any related financial metric and is limited to the net paid account number only.
Our installed base continued its growth trajectory and reached $2 3 million paid accounts in Q2.
As mentioned earlier service revenue accounted for 44% of our Q2 2023 revenue.
And importantly represented 88% of our total gross profit.
Additionally, our quarter end.
<unk> was $194 million.
Up more than 66% year over year, and providing another proof point of the tremendous growth of our services business.
Product revenue for Q2 was $64 $7 million, which was down about 3% sequentially and 25% year over year.
During the quarter, we shipped a total of 954000 cameras worldwide compared to $1 1 million in the.
The prior year period.
Product revenue was impacted by a slight decline in shipment volume, but more so due to declines in average selling prices driven by a deliberate shift in our pricing strategy and mix in global product assortment.
In the quarter, approximately 32% of our revenue originated from our international customers.
Our EMEA results were impacted in Q2 as our largest partner continues to constrained inventory levels a cycle other channel partners went through in previous quarters.
We are confident this is not an end market demand issue and I expect this near term response to macro conditions in the region to moderate over time.
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 second quarter was $43 million up 23% year over year.
This resulted in a non-GAAP gross margin of 37% up 470 basis points from 33% in Q1 of 2023.
The year over year increase in non-GAAP gross profit in Q2 was attributable to the growth in our service business the.
The improvement in non-GAAP service gross profit was driven by growth in our subscriptions and planned pricing coupled with cost optimizations.
non-GAAP service gross margin for the quarter was 75%.
Slightly up from 74% in Q1 of 2023 and significantly up from 66% in Q2 of 2022.
non-GAAP product gross margin for the quarter was 8% and consistent with our guidance provided in March of this year.
Furthermore, we are very pleased that our services non-GAAP gross profit exceeded our non-GAAP operating expenses in the quarter.
This was an important achievement for the Arlo team, thereby validating our ability to transform into a sustainable operating model around our services business now and well into the foreseeable future.
Total non-GAAP operating expenses for the second quarter were 37 $5 million up sequentially and year over year by less than $3 $5 million.
The year over year increase is attributable to continued investment in sales and marketing expenses to help drive household acquisition.
Paid account growth.
The non-GAAP operating expenses for the first half of 2023 were slightly better than our expectations and reflect the cost savings initiatives implemented in Q4 of last year.
Our head count at the end of Q2 was 345, which represents a slight change from 334 team members at the end of Q1.
And 354 team members in the same period last year.
In Q2, we posted non-GAAP net income of $6 $1 million.
Our non-GAAP net income translates to earnings per diluted share of <unk> and.
And at the top end of our guidance range provided last quarter.
The marked 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.
Regarding our balance sheet and liquidity position.
We ended the quarter with $123 $7 million in available cash.
Cash equivalents and short term investments.
This balance was up $5 million sequentially and is trending in line with our expectations.
We are pleased to report that we generated approximately $11 $5 million in free cash flow in Q2, which represents free cash flow margin of 10%.
An improvement driven by our increased profitability.
And solid working capital management.
Additionally.
Our Q2 inventory balance ended at 39 point of $4 million.
Representing a slight decrease from Q1 of 2023 with inventory turns at six one times and relatively consistent with last quarter.
As Matt mentioned, we are launching a broad assortment of new products in the second half of 2023.
Which will enable us to remain highly aggressive with our product pricing strategy, particularly through the seasonally strong holiday season and into 2024.
We remain focused on maintaining appropriate inventory levels to effectuate, a smooth product transition with retailers and partners, while being able to meet any potential upside in consumer demand that may be experienced.
These factors may impact, our inventory balance and thereby our ability to generate similar levels of free cash flow as working capital may fluctuate.
And finally, our accounts receivable balance was 57 3 million as of July 2nd with Q2, Dsos at 45 days.
Down from 57 days from the same period last year.
We will continue to monitor our working capital balances in line with our revenue and forecasted consumer demand levels with a focus on maintaining a solid balance sheet and liquidity position in the future.
Now turning to our outlook.
While we remain cautious about our product revenue outlook for the year, we expect the third quarter revenue for 2023 to be in the range of $122 million to $132 million.
We expect our GAAP net loss per diluted share to be between <unk>.
<unk>.
And our non-GAAP net income per diluted share to be between <unk> and 10 <unk>.
Per share.
We reiterate our 2023% full year revenue guidance range to be between 470 and $500 million and that our service revenue is forecasted to grow at roughly 48% year over year to approximately $200 million.
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 paid accounts. However, we expect non-GAAP service gross margin to be at or above 75% in two.
23.
And now I'll open it up for questions.
At this time.
I'd 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 Hamid <unk> with B Ws Your line is open.
Hi, So first question I had was could you just talk about this inventory issue with very sure yes, how.
How much inventory do they have and why are they being so cautionary and then also if you could also.
A little bit more understanding as to what this catch up is and why is it noncash and how did you find out about it.
Yes, I think what we're seeing with <unk> is very similar to what we saw with retailers.
Our retail channel as an example at the end of last year, where they are really managing their inventory to a target number and very sure we see doing that this year.
The exact amount, we don't know, but we can see them managing their inventory down and we have a we have visibility into a much longer forecast with them. As you know we have a great long term partnership with them. So we can see that recovering.
After after theyre going to hit whatever target Theyre trying to hit internally. So I think it's I think it's very similar to what we saw the retailers due at the end of last year.
And now theyre going through that same cycle.
Today this year.
The catch up it was roughly October of last year, when we saw it but thats when it started.
The product, meaning the cameras that are being installed are being installed at the location at the household.
Which means for us the cost we do a cost plus model. So the costs in our cloud are accurate, we mark that up we charge them like we've talked about in our pricing model with BW customers.
But the actual count of the household or the paid accounts with not being incremented correctly, so bearish or is pushing for more updates out to what they call their central units to fix that overtime and so thats. What you can see some of the catch up this quarter and we think that will continue to roll that out through the end of the year. So we'll see a little bit more catch up each quarter, if you back.
I'll just give you. An example, if you back out the catch up we saw this quarter, we were at kind of the high range of our normal range of ads for the quarter anyway, So call. It 185 plus.
Accounts for the quarter before <unk> catch up.
As they deploy firmware and roll that out.
Okay.
And the follow up I had was.
In Q2 as far as hardware is concerned how much of the revenue was.
That land as far as the Prime day is concerned and what are you seeing as far as.
Activity wise now that Prime day is over or are you seeing that the attach rates still stay around that 50% Mark you've been talking about for a while.
So the first part I'll answer that we saw that there was a couple of factors impacting this quarter first we did see selling fairly strong as a result of the promotional activity that we've been embarking on for the better part of the last six or seven months.
As a result of that the natural seasonality played in our favor for Q2, but compounding that was the fact that we did have a fairly significant load in for Prime day I'm sure Matt will touch on this a bit more of a prime day was a great success for us and we've also seen similar loading for a couple of other key retailers like for instance, <unk>.
Cosco.
It was a relatively strong quarter as it as it relates to to the load in for those retailers retailers are for the most part at a good inventory level here in the U S and so we do expect especially in the second half that the demand will continue as we become are continuing to be promotional.
And just a follow up on the second part of your question around customer sentiment.
<unk> touched on it and we touched on it in the script.
Prime day was strong and that is kind of a continuation of what we've described as I think resilience in the last couple of quarters around consumer demand our pricing strategy is definitely driving consumer demand I think demand is relatively strong we do have good inventory levels in the channel you can see our inventory actually came down.
So we're bringing in more product so we're feeling pretty strong around how the how the consumer is reacting to our pricing strategy our value proposition across multiple channels Prime day was a great example of that.
And we have a very robust plan across multiple channel partners in the second half. So we're excited about the household formation, we're going to see going into Q3 really Q4 going into 2024 around what that's going to mean for future service revenue.
Okay. Thank you.
Youre welcome.
Your next question comes from the line of Jacob Steven with Lake Street. Your line is open.
Hey, guys. Congrats on the results and thanks for taking my questions here.
So I'm just kind of wondering when I think about the holiday stocking period coming up here.
Inventory levels stable sequentially.
What are those initial conversations been with kind of the U S Big box retailers, the best buys of Costco's.
And just any color on that would be helpful.
Yes, so planning for a second half.
Promotional period actually starts.
Nearly the end of last year and gets a little bit more specific and I would say detailed as we go into Q1. So a lot of the planning for this has been in Q1, and we have been and obviously execution mode. We commented I think both Kurt and I commented that we have a new product line launching that we're very excited about.
Coming in this timeframe and so some of that will load in in Q4. Some of that may loaded in a lot of them a loaded in Q3 and some of it some of it. When we look ahead is how much of that lands in Q3 versus Q4 that has to do with freight and other things in speaking with our retailers.
The sentiment right now is relative optimism I would say for the second half.
And that's around both I'd say in general despite some concern about consumers theyre seeing relatively good foot traffic and we're seeing relatively good sales and then I would say specifically around arlo. The success. We've had in the first half of this year, our pricing strategy generating additional sales for them in.
In the segment and I can tell you, it's pretty clear that our LOE is actually capturing share in the market. So I would say there is a relative maybe cautious optimism and just the general consumer market from the big box retailers as we plan for the second half together over the last six months, but I think there are specific excitement around our low what we're doing.
Our pricing strategy, our new products that are coming out and the plans that we have both on our placement level, but also a promotional level in the second half.
Okay got it and maybe just touching on kind of are sure.
Channel Destock.
Destocking.
So the 10-Q, you had roughly $39 million in backlog as of June 30th.
So is this destocking coming after kind of what the quarter end here, so that maybe that $39 million in backlog might be lower than that or.
Is that incorporated into the Q2.
Yeah, I wouldn't I wouldn't read into that too much Jacob I think that right now from what we're hearing and we're working with bearish or on a week to week basis, but they have a clear inventory target that they are going to hit for the end of this year and thats been factored into the placement that you are currently seeing just to give you.
An overview of what we're seeing right now we have the $500 million commitment from various show, we're about $400 million sitting as of today and we do see a path to exceeding that well exceeding that almost by the second quarter of next year. So we also see that the end market demand in EMEA.
<unk> is still pretty resilient. So although they are kind of destocking and working to hit a specific inventory target for the end of the year the demand still looks to be very healthy and resilient, especially going into Q1 of next year. So we don't feel like there's any major concerns around the end market demand thats out there.
Yeah.
Okay got it that's really helpful I'll jump back in the queue. Congrats again thanks.
Thank you very much.
As a reminder, if you would like to ask a question press star followed by the number one on your telephone keypad.
Your next question comes from the line of Jake <unk> with Raymond James Your.
Your line is open.
Thank you so much good quarter guys. Firstly, I just want to start from a higher level.
Can you talk about and give us a sense internally, where youre seeing mix of products versus services, particularly as we look to fiscal 'twenty four.
How high do you think this can go and maybe any visibility as to when that might crossover the 60% Mark.
Yes, great question. So we've been focused on driving the overall percent of our services revenue higher with the overall combined revenue and as you.
As we pointed out in our prepared comments this quarter, we hit the 44% Mark which was which was fantastic as you know that revenue that service revenue is generating around the 75% gross margin and we were Super pleased with the fact that that overall on an absolute dollar base.
<unk> gross margin covered our entire operating expense for the non-GAAP operating expense for the quarter. So it was a big milestone in our milestone I think we had communicated before but it was probably positioned to be more of a Q3 or Q4 events. So we were super pleased that we were able to do that in this quarter. As you look forward in terms of our overall revenue mix.
I think for the full year, we will be at or above that 40% target and then going into 2024, we will be moving rapidly up towards 50%. Our goal over the long term is probably somewhere between 50, and 60% and we have a clear line of path to that but it will take us a little time ending this year at <unk>.
<unk> 40, and then moving quickly from 40 to 50 towards the end of next year.
Okay. Thanks that was very helpful. And then last one from me.
Other sort of high level, how are you guys thinking about channel mix as we enter 2024 and may be just any guardrails around how low retail and e-commerce as youre willing to go there.
Yes, its more its more a question of the relative growth between the two so give you a little history.
When we spun from NEC here, a while back 83% roughly of our revenue was from what we would call traditional retail so retail E comm and like now its closer to maybe 50 45, 40% to 45%. So a lot of that was a strategic initiative internally to diversify our revenue base and we saw.
Significant opportunity in what we call strategic accounts or <unk> partners, obviously very sure being the largest of those partners. So it's to me both will grow.
We're seeing growth in the retail channel now as we mentioned earlier on the call. We feel we're capturing share and some of those traditional retail channels and our pricing strategy is working.
And we're seeing growth across.
The long term across new strategic accounts and our existing strategic accounts, so as far as what the balance will be it's a question around relative growth between the two I.
I would say there is significant opportunities on the strategic account basis and that might drive additional growth or higher growth on a relative basis. As you look out over the next 12 months to 24 months.
But on the retail side again, the market is actually flat to down right now and we're growing so we always try and grow our retail and track.
Account market faster than the market and we're being very successful at that so I don't have a hard number for you, but I would say there is additional upside on the strategic accounts.
Just because theres so many potential opportunities over the next 12 to 24 months.
Awesome appreciate the color congrats on the quarter guys. Thank you.
Yes.
Your next question comes from the line of Ryan <unk> with Craig Hallum. Your.
Your line is open.
Hey, guys Ryan on for Tony Thanks for taking my question.
Just kind of clarify on the subscriber add with the virus or catch up I guess kind of netting out that Mercer catch up we're looking at kind of throughout the year or are you still I mean for next quarter and for Q4, you're still expecting kind of that 185000 paid subscriber adds per quarter I guess, how does that look going forward.
Yes, so so our normal runway I think stays the same and what I mean by that is what we're organically generating from multiple channels is somewhere between 170, and 190000 paid accounts a quarter and thats kind of the range that we've communicated I think thats still true although like I said in this quarter I think we were probably on the high end of that right.
We had a successful quarter on paid accounts then you add on additional catch up. So this quarter, we were closer to 240 245000 paid accounts I.
I think we will see similar catch up again, it can be plus or minus as we go as we go into quarters and depending on how many firm or upgrades. They do as we roll through the rest of the year, but again those arent, adding financial metrics like service revenue. It's just a catch up of the absolute value of number of accounts because of our under accounting of those paid accounts. So I think when youre modeling.
From a financial perspective in service revenue that 170 to 190000 range is the right way to think about it and then just know there is some catch up happening on the paid account number but its not affecting the underlying financials.
Okay, great. Thanks, guys congrats on the quarter. Thank.
Thank you.
There are no further questions at this time and this concludes today's conference call. Thank you for attending you may now disconnect.
Okay.
Okay.
Okay.
Yes.
Yes.