Arlo Technologies Inc (ARLO) 2018 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. (Operator Instructions)

I would now like to turn the conference over to Erik Bylin. Please go ahead, sir.

Thank you, Jessie. Good afternoon, and welcome to Arlo Technologies Fourth Quarter of 2018 Financial Results Conference Call.

Joining us from the company are Mr. Matthew McRae, CEO; and Ms. Christine Gorjanc, 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 fourth quarter and full year along with guidance, provided by Christine. We will then have time for any questions.

If you've not received a copy of today's press release, please visit Arlo's Investor Relations website at investors.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 expected revenue, gross margins, operating margins, tax rates, expenses and future business outlook. 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 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 mentioned on this call. Reconciliation of the non-GAAP to GAAP measures can be found in today's press release on our Investor Relations website.

At this time, I would like to turn the call over to Matt.

Thank you, Erik. And thank you, everyone for joining us today on Arlo's Fourth Quarter 2018 Earnings Call.

The past year was a transformative year for Arlo, as we finalized the separation of the company and completed our first full quarter of operations as a stand-alone company.

In Q4, we delivered $129.3 million in revenue, year-over-year growth of 4% and near the high end of our revised guidance that we provided in December.

Services revenue was $10.7 million in the fourth quarter, up 20% year-over-year and comprised 8.3% of total revenue.

For the full year, Arlo achieved revenue of $472 million for growth of 27% year-over-year. In Q4, we added approximately 350,000 registered users to the Arlo platform, highlighting a strong end-user demand and have grown the total by more than 71% year-over-year. We are pleased to say that Arlo now has 2.85 million registered users. By the end of Q4, our paid subscriber base had grown to approximately 144,000, up 85% year-over-year. Arlo subscriber base continues to outpace the growth of our new registered users.

According to NPD, while the market for U.S. consumer network-connected camera systems grew 35% year-over-year in 2016 and 2017, the growth of this market slowed considerably to 16% in 2018. With higher market growth expectations, our retail partners brought in more Arlo product than the market could absorb, and we expect them to return to normal inventory levels by the end of the second quarter of 2019.

While I'm disappointed with how this will affect our guidance for the year, I remain confident Arlo's long-term outlook remains bright. Christine will share more detail on this in her prepared remarks.

Despite the market slowdown, Arlo's value proposition continues to resonate with customers, which keeps us in a dominant market share leadership position. In the fourth quarter, according to NPD, we have held a market share result of 41%. We achieved this through the years with the continuous stream of innovations that have put us at the forefront of features and functionality. Arlo, as you know, was the first to deliver a truly wire-free camera to the consumer IoT and security industry. And we have continued to innovate with Arlo Smart services, which includes our class-leading AI and computer vision capabilities as well as our cellular camera, Arlo Go.

I was excited to launch our highly anticipated Arlo Ultra camera at CES. Ultra is our latest flagship wire-free security camera system, powered by the Arlo SmartHub. Ultra integrates advanced features such as 4K video with color night vision, a 180-degree field of view, an integrated spotlight and crystal clear 2-way audio with advanced noise cancellation. This camera is well ahead of competition, and is the most advanced DIY monitoring solution available. We are bundling Ultra with a 1-year free subscription to Arlo Smart Premier, our AI-powered service that provides cloud storage and sophisticated detection of people, vehicles, packages and other objects.

Coupling our Smart Premier service with the Ultra camera will enable a new business model to drive future growth of our paid subscriber base.

We also expanded our smart home footprint into the home security market with the announcement of the Arlo Security System, which will increase our addressable market. At the heart of the system is an all-in-one Multi-Sensor, which integrates numerous intelligent sensors into an extremely small package. The innovative Multi-Sensor can detect open windows, open doors, motion events, smoke alarms, carbon monoxide alarms, water leaks, gas leaks and key temperature changes, including detecting freezing conditions. Any unwanted activity picked up by the Multi-Sensor can be instantly communicated to other Arlo products through connected SmartHub to the mobile app, allowing homeowners to take immediate action. With a siren and a remote, the new security system is at the forefront of innovation. And I believe it exemplifies the future possibilities of the IoT smart home market. Components of the security system will begin rolling out in the second half of 2019. And we expect this product will drive more paid subscriptions.

The introductions at CES garnered a broad set of accolades. First, the Arlo Ultra camera was named an official CES 2019 Innovation Award honoree, a distinction that celebrates outstanding design, functionality, consumer appeal and engineering. Ultra was also awarded a CES 2019 Editors' Choice Award by USA TODAY and review.com, based on innovation, technology, design and value.

Further, the website, AndroidPolice, awarded the Ultra -- both Ultra and security system their best at CES 2019 awards. Techradar selected the security system as the best Smart home tech of CES 2019. And finally, The Ambient, a website dedicated to smart home news, selected the security system as a smart home top pick for 2019. At CES, the amount of innovation on display was very impressive. And it was clear that Arlo continues to lead the industry.

Despite a slowing market and the resulting near-term challenges, we are confident that our market-leading products and commitment to innovation will continue to provide Arlo with a strong foundation for success. I remain optimistic that Arlo will remain the market leader and accelerate its path to long-term profitability and subscription growth.

I'd like now to turn the call over to Christine for her commentary on the fourth quarter and guidance for the first quarter and full year.

Thank you, Matt, and thank you all for joining us on Arlo's Fourth Quarter 2018 Earnings Call. As Matt shared, the fourth quarter, we recorded $129.3 million of revenue at the high end of our updated guidance and an increase to 3.6% year-over-year.

Our services revenue for the quarter was $10.7 million, which is up 19.6% year-over-year.

For 2018, we recorded $472 million in revenue for a growth of 27.3% over 2017. As a reminder, the year-ago comparison period references carve-out financials for Q1 and Q2, whereas, our Q3 and Q4 results are based on stand-alone financials. You can find further detail regarding Arlo carve-out financials contained in our SEC filings, including our previously filed Form S-1 and the related public offering prospectus.

During the fourth quarter, we shipped a total of 1.7 million devices of which 1.6 million are cameras. We added approximately 350,000 registered users to the Arlo platform in Q4. As of the end of the fourth quarter, we had about 2.85 million registered users, which is 71% more than we had a year ago. We continue to believe that growing our registered user base is critical to growing our recurring subscription business.

Our paid subscriber count for Q4 was approximately 144,000, which is up 85% year-over-year. We're very pleased with the growth in our paid subscriber base and believe our new business model for Ultra will be a big driver of this subscriber base in the future.

Our services revenue for Q4 '18 was $10.7 million, which is 9% quarter-over-quarter growth.

From this point on, my discussion points will focus on non-GAAP numbers. The reconciliation from GAAP to non-GAAP is detailed in our earnings release distributed earlier today.

Our non-GAAP gross profit for the fourth quarter of 2018 was $12.7 million, which resulted in a non-GAAP gross margin of 9.9%, in line with guidance. This compares to $30.4 million in the year-ago comparable period and $30.4 million in the prior quarter.

Note, the year-ago comparison period references carve-out financials, whereas, our Q3 and Q4 results are based on stand-alone financials.

Total non-GAAP operating expenses came in at $37.8 million, which is up 57.6% year-over-year and up 10.8% sequentially.

Once again, the year-ago comparison period references carve-out financials, whereas, our Q3 and Q4 results are based on stand-alone financials.

Our headcount at the end of Q4 '18 was 386 employees. We are strategically investing in the areas which we believe are key to the growth of our business while adding the resources necessary to operate as a stand-alone public company.

Our non-GAAP R&D expense for the fourth quarter was 12.4% of revenue, an increase of 80 basis points from 11.6% of revenue in the prior quarter.

R&D is critical to our products and service differentiation, and we continue to invest heavily in R&D for Arlo as we execute our hardware and services road maps. We expect our R&D expense to continue to grow in absolute dollars.

Our non-GAAP tax expense for the fourth quarter of 2018 is $258,000. For the fourth quarter of 2018, we posted a non-GAAP loss per share of $0.33.

We ended the quarter with $201 million in cash and cash equivalents and short-term investments. As a reminder, in Q3 '18, we received approximately $173.4 million in net proceeds from the IPO after deducting IPO-related fees paid for by Arlo and approximately $70 million from NETGEAR prior to the IPO.

Now, I would like to turn to our outlook for 2019. To recap what Matt shared, the market growth rate for connected cameras slowed from about 35% in 2016 and 2017 to about 16% in the 2018. The market growth decline has a twofold effect on our growth rate. Firstly, the slowdown is a reflection of slower revenue growth in consumer demand for cameras. However, there was a secondary effect that compounds the impact on our revenue guidance. Market revenue growth was considerably lower in the fourth quarter. But our retail partners were stocking in line with the anticipated growth of a normal holiday uptick. As a result, our channel partners exited the year with much higher than normal inventory levels.

Given the information we have today, we anticipate the slower market growth that we witnessed in Q4 2018, and are seeing in early 2019, will continue to impact us for the first half of 2019 as our channel partners return their inventory to normal channel inventory levels, which will require a higher promotional spend coupled with lower shipments to our customers, both of these will adversely affect revenue.

Taking these factors into account, we expect revenue in the first quarter to be in the range of $48 million to $52 million. We expect our non-GAAP gross margin to come in between negative 1.3% and 1.7% and non-GAAP gross margin to come in between 0% and 3% in the first quarter of 2019.

We expect our GAAP EPS to come in at negative $0.59 -- between negative $0.59 and negative $0.53 and our non-GAAP EPS to come in between negative $0.51 and negative $0.55 per share.

Our GAAP and non-GAAP tax expense will be approximately $300,000 for Q1 '19.

Looking at the full year, we expect a moderate recovery in the second quarter as the promotional spending slows and Q2 will be the first full quarter of Ultra sales across the channel. In our seasonally strong second half of the year, we expect to have normalized channel inventory and anticipate a meaningful contribution from our new product introductions.

We believe this will result in modest year-over-year growth for the second half of 2019. With that, we expect revenue to come in between $380 million and $420 million for the full year 2019. We believe our non-GAAP gross margin will improve in the second half of the year to mid-teens. We expect our GAAP operating loss will be in the range of $118.7 million to $128.7 million, and our non-GAAP operating loss will be in the range of $95 million loss to $105 million loss for 2019.

Operator, that concludes our prepared comments. And we can now take questions.

(Operator Instructions) Your first question comes from the line of Adam Tindle with Raymond James.

I just wanted to start on paid subscribers. I know that number is increasing, but it's still about the same percentage of registered users. Continuing to have to add users is costly. So I'm just hoping if can maybe touch on a little bit on puts and takes to instead spending on getting more brought up taking the existing base to increase the percentage of paid users in the existing base?

Yes. We're focused on both. And you're right, there are puts and takes, and it depends on the timing in the year. There's 2 main paths to generate paid subscribers historically. And then we've added one, as you know, through the new business model with Ultra. So if you look historically, one of the primary ways was us marketing to our installed base. And that's something we continue to do. And drove a bit of the growth that you're seeing in Q4 in paid subscribers. And those are offers that go to our 2.85 million registered users, especially when we launch new features like we did in Q4 and plan to do in 2019. The other is new users. When they out-of-box a new system and we give them a 30-day free trial, and then attempt to convert them from that. And we characterized the conversion ratio from free trial into the paid subscribers being a healthy number, something we're happy with. But I think from the most impact perspective going forward is the new business model that we announced with Ultra and have started to ship where we're prebundling a service period with the product when purchased at retail and believe that, that will drive a higher subscription attach as we go forward.

Okay. That's helpful. Maybe one for Christine. Can you maybe just touch on the cash burn rate expected in 2019? And you've talked about the channel inventory a little elevated. Is -- could cash burn be higher than the operating losses that you're guiding to? Just give us a sense of bracketing that.

No, I would expect it -- the cash burn to be approximately the operating loss. The other 2 factors affecting that are depreciation and amortization will be a credit of somewhere around $8 million and then CapEx around $12 million. So there's a net $4 million there.

Okay. And then if you could maybe just touch on -- remind us on some of the nuances to Arlo as a potential. I know there's been a lot of volatility in the public markets for the stock. The nuances to Arlo as a potential target for an acquisition, the timing of when you'd have to wait for that from a tax perspective and all that.

Yes, I don't have enough information at my fingertips on that, to be completely accurate as far as the tax. But as far as I know, with the tax-free spend, there's obviously several safe harbors under that and -- or you pay the tax. So I don't have that information at my fingertips right now.

Okay, no problem. Just maybe one final clarification on guidance. Sorry if I missed this. But I think the math would imply that in Q2 and beyond, your gross margin would have to be somewhere in kind of the high teens rate. Is that a fair assumption? Just touch on what kind of gross margin we can expect.

I think basically what I said at the end of the script is we would expect in the back half of the year, mid-teens, given the guidance in that, and that kind of rolls into the bottom line operating loss.

Your next question comes from the line of Jeffrey Rand with Deutsche Bank.

Just a quick question on the gross margin outlook for the first quarter. Obviously, it's pretty low. How much is the, kind of, contra revenue impacting that? And how much is other things like underutilization impacting that?

No, I would say it's a combination. Clearly, we continue to promote and some of that is without orders from the customers, and then there are also some fixed costs that as the revenue -- or the growth shifts are lower, that will be a higher percentage of the total.

Great. And just as a follow-up. In, kind of, the first half of the year and, kind of, other times when things get slow, how much flexibility do you have to lower operating expenses?

We, obviously, always have flexibility with our hiring plans, with our outsourcing and everything. So we will obviously take a good look at that. And as we continue to go through, we will watch that very carefully.

Your next question comes from Saliq Khan with Imperial Capital.

Just a few quick questions on my end, guys. First one being is you had already taken the Q1 guidance down back in December due to the timing issues with the Ultra. So how much of the impact that we're seeing with the Q1 revenue guidance right now is due to Ultra versus some of the other market conditions that you alluded to?

So as we said in December that we were basically pushing forward Ultra into Q1 from Q4, which means that Ultra starts going into distribution in Q1 and is in full distribution in Q2, the majority of the -- when I look at the year-over-year decrease in the revenue, from $100 million a year ago to the guide today, is not related to Ultra. That is really more related to the market slowdown and then in addition to that to the channel inventory that we see or that our partners have because we really did see the last 6-week selling period of 2018 not materialize with the holiday uptick that we expected.

And then, Christine, are you seeing any impact at all from competition out of the Amazon, SimpliSafe or even the traditional security providers?

We're in a market with big competitors. But we also have showed the 41% market share achievement in Q4. So we're, obviously, staying focused on what we do best around innovation and everything else. And the growth drop-off in December is really what affected the quarter.

Got it. And then one final one on my end. Matt, one of things you, kind of, talked about in your opening remarks was the NPD data. A lot of the data work that they do is on the consumer network market or the network IP camera marketplace. So if that is slowing down, is there a way for you to repurpose or refocus your efforts towards the commercial, the [FMV] market? Is that an opportunity for you to be able to offset some of the slowdown in the consumer market?

Yes. It's a good question. And it is something we've commented in the past. There is 2 things that are coming that we've commented in the past. One is, yes, you're right, there are incremental channels, and we're starting the business development areas in some of those yet. We're not ready to announce those. But I do believe diversification of channel is something that we're focused on as we go forward. And in addition, we've talked about the more robust product cycle in the second half of 2019. And you could foresee those moving into some of the new categories, for instance, the security device we announced at CES.

Your next question comes from the line of Woo Jin Ho with Bloomberg Intelligence.

Couple of things in terms of the inventory that's in the channel. Can you just talk a little bit briefly on the constitution of the inventory of the channel? Is it predominantly the Arlo Pro and the Arlo standard and the Pro 2s that are just being backlogged? Or is it also Arlo Ultra that's being slowed down, especially given the slow reception that you've had for the product?

Yes. It's not Arlo -- Ultra wasn't even in the channel at 12/31. So, to be honest, it's a mix of all of our products. It's the original Arlo that's been out since 2015 and Pro which are our older products. Pro 2 is in there too. And then there's some other things like Lights and Baby and a few other things in the channel. So it's really quite mixed.

And then in terms of the first half gross margin guidance, implicit in the gross margin guidance, it seems as if you're going to aggressively promote to clear up the channel. Is that the right way of thinking of it? And then have new products on the second half to ramp up to your $400 million guidance for the year?

Yes, absolutely.

Okay. And then just to be clear, based on your cash flow -- cash burn comment, Christie, do you expect to end the year with roughly about $100 million in cash? Or could that potentially go a little bit lower?

Obviously, our goal is to end the year with $100-plus million of cash, and we'll continue to move forward that. There is a lot of balance sheet management that we can also do.

Are there any other sources of cash that you can tap into?

I think there's -- we have options out there, but nothing at this point in time.

As there are no further questions for this call at the time. This concludes today's conference call. You may now disconnect.