Arlo Technologies Inc (ARLO) 2022 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 Eric Bylin. Please go ahead, sir.

Thank you, operator. Good afternoon, and welcome to Arlo Technologies Fourth Quarter and Full Year 2022 Financial Results Conference Call. Joining us from the company are Mr. Matthew McRae, CEO; and Mr. Kurt Binder, CFO. The format of the call will start with an introduction and commentary on the business provided by Matt, followed by a review of the financials for the fourth quarter and full year, along with guidance for the first quarter and full year provided by Kurt. We'll then have time for any questions. If you have not received a copy of today's release, please visit Arlo's Investor Relations website at investor.arlo.com.

Before we begin the formal remarks, we advise you that today's conference call contains forward-looking statements. Forward-looking statements include statements regarding our potential future business, operating results and financial conditions, 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 services-first business model, the commercial launch and momentum of new products and services, strategic objectives and initiatives, market expansion and future growth, the effect of our brand awareness campaign on future growth, partnership with various market leaders, continued new product and service differentiation, supply chain challenges, transportation costs and the impact of 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 Arlo's periodic filings with the SEC, including the most recent Annual Report on Form 10-K and quarterly report on Form 10-Q.

Any forward-looking statements that we make on this call are based on assumptions as of today and Arlo undertakes no obligation to update these statements as a result of new information or future events. In addition, several non-GAAP financial measures will be discussed on this call. A reconciliation of the GAAP to non-GAAP measures can be found in today's press release on our Investor Relations website.

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

Thank you, Eric, and thank you, everyone, for joining us today on Arlo's Fourth Quarter and Full Year 2022 Earnings Call. Despite softening consumer demand and tightened retail inventory levels, Arlo 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 189,000 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. Argo produced total revenue for the full year of $490.4 million, a growth of 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 7-percentage point increase in service gross margin to 67%. And if you remove our discretionary marketing spend, Arlo delivered 4 quarters of non-GAAP operating profit in 2022. And I'm thrilled to announce that Arlo will surpass 2 million paid accounts next week, more than doubling our subscriber base over the last 5 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. To be clear, when looking at total service revenue and our annual recurring revenue, Arlo service business is growing at roughly 50% year-over-year, has 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 2023. These numbers illustrate the current valuation dislocation and the immense upside at Arlo.

Driven by our services business, Arlo is expected to cross over 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 Arlo's services first transformation to generate outstanding shareholder value. From a technology perspective, Arlo continues to win on innovation and experience. Arlo was recognized as "the Apple of smart cameras" by P3, and the "connected home Company of the Year by the IoT Breakthrough Awards." Our cameras won numerous awards in 2022, including a mention in Time Magazine's "Best inventions of 2022" and have already won best of 2023 awards for Men's Health Tech, TechHive, Review.com, Digital Trends and multiple awards from CNET in the smart camera and doorbell categories.

Arlo also expanded our offering to include a powerful security system with 24/7 professional monitoring featuring a truly innovative all-in-one sensor that provides significant advantages for users and channel partners. This allows Arlo to directly address the broader global home security market, which is roughly $50 billion and 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. Arlo now has a full security solution to directly replace that functionality, significantly upgrade the capabilities and substantially improve the user experience. We are 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, I will 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. Arlo 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, Arlo 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 at Arlo 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 households 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. Arlo looks to leverage this unique sales model and partnership to acquire incremental paid accounts in new market segments where users prefer not to pay for the system upfront. The first offers will roll out in the second half of this year.

As you look to our 2023 guidance, you will see a rebalancing of Arlo's pricing model that will accelerate growth, increase service revenue and allow Arlo to address a wider market segment than ever before as we trade a hardware revenue and hardware margin for incremental new paid accounts and higher service margin. And due to 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 Kurt, 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 Arlo 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 $490.4 million, up nearly 13% year-over-year and within our original annual guidance range. We were pleased that our channel diversification and ARR growth demonstrate the resilience to deliver revenue within our guidance range. Our strategic shift to a services first operating model was instrumental in driving our year-end ARR to $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 35% year-over-year and an increase of $2.9 million or 8% quarter-over-quarter, driven by the addition of 189,000 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 795,000 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 Verisure and EMEA, with revenue up 46% year-over-year. Our ability to develop such a strong and collaborative relationship with Verisure 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 is 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 improvement in non-GAAP service gross profit was driven by growth in our ARR 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 4 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 headcount 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 excluding the brand awareness spend. Our non-GAAP net loss translates to a net loss per diluted share of $0.04, much better than our Q4 guidance of a net loss per diluted share of $0.09.

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 of spend. Our non-GAAP net loss translates to a net loss per diluted share of $0.07, much better than our full year guidance of a net loss per diluted share of $0.12 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 headcount, 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 is 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 had 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 6.4x as compared to 4.3x 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 Arlo to be materially profitable this upcoming year. Specifically, we expect our gross profit from services alone to exceed our operating expenses, 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 will 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 expect our GAAP net loss per diluted share to be between $0.23 and $0.17 and our non-GAAP net loss per diluted share to be between $0.07 and $0.01 per share. Our Q1 2023 guidance takes into account approximately $600,000 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 our product sales potential headwinds in the European region and heightening 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 the 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.

(Operator Instructions) Your first question comes from the line of Jacob Stephen with Lake Street Capital.

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, your best buys and your cost cause and then maybe contrast that with kind of the strategic partners?

Yes, absolutely. And thanks for the congrats on the quarter. We feel really proud of what was accomplished and our outlook for the year. 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 in the normal consumer channels that you've mentioned. And that continues into Q1 and you see that reflected in the guidance. And I would say that's true across channels. So we don't -- we haven't seen the demand really drop 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 Kurt's comments just because of the macroeconomic situation there vis-a-vis the United States. But overall, I would say we're seeing some resilience in the demand for home security, but also Arlo in particular. And that's reflected not only in the quarter results, but in the guidance that you see us articulating going forward.

Okay. So maybe just focusing on kind of inventory levels and gross margins in Q4 here. Was kind of the margin decrease the result of the sales you guys were running? Or I guess, what -- kind of what was the margin pressure there?

Well, I think on the product or hardware margin side, we were ensuring that we recovered from an 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 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 that we see that going into the first part of 2023 and trending up, as we mentioned in the guidance.

I think if you look at 2023, we do believe that we can be very promotional in -- 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 that's super exciting. And then of course, we want 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 hardware or product gross margin might be a bit under what was expected in Q4, we think that, that will be a key lever going into 2023 to help us drive the new household formations and incremental subscriber growth.

Okay. Got it. Yes, 2 million paid subs is certainly an excellent milestone. Maybe just one last one. Looking at the new security system launch. Any early comments you guys can make on kind of what you're seeing?

Yes. It's -- we've got it in a couple of channels now. You'll see the rollout, as we mentioned in the prepared remarks, grow not only in additional retail locations, but probably with a strategic partner to -- as we go through this year. Initial feedback has been great. If you look at some of the reviews, they're 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 product is getting better and better by the week. And we're looking forward to actually distributing it on 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.

Your next question comes from the line of Jake Norriton with Raymond James.

I just had -- 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. I think that when you look at mix for 2022 and then on Q4, we were trending in sort of that 20% to 30% of our revenue coming from services and 60% to 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's going to be a considerable uplift in the services revenue and especially as a portion of the overall total revenue, we would expect that the mix would shift from, say, that 30% to probably higher -- maybe exceeding 40% into the 45% range of total revenue.

So 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. That's a big part of our overall strategy because as we mentioned before, driving the subscriber base, getting ARPUs up and really targeting cost optimization to drive that margin expansion is really, really important for us.

Awesome. And then last one for me. Can you just provide any metrics around the growth of Arlo Safe? What are you seeing there in terms of customers outside the Arlo ecosystem choosing Safe as their entry point to Arlo? Just any color there would be helpful.

Yes. It's Arlo Safe actually a very exciting product for us. And then when I say product, it's 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 to 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 in a higher-priced tier. So in our now $25 pricing per month tier includes Arlo Secure, which is the professional monitoring for all of our cameras and security system and Arlo Safe. And it's a little early to provide some metrics. But Kurt just alluded to some ARPU 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 Arlo from protecting a location with its hardware and Arlo secure service to actually protecting families and other -- and individuals on the go. And it's resonating quite well. I do believe also that you'll see some action in some verticals with that space as far as Arlo Safe over time as well. So we think there's some deep partnership opportunities that will provide some additional upside as we get through 2023.

Your next question comes from the line of Hamed Khorsand with BWS.

Could you just talk about the customer demographics of the households you're now targeting with the approach of having lower price point on the hardware? How sticky are they to just continuous pay for that monthly subscription?

Yes. It's something we've looked at quite a bit. And when you looked at the market data a couple of years ago, some of the very low-price points, not that we'll hit some of 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. And as we on promotion has hit some relatively low-price points through Q4 for holiday promotions, we're seeing very consistent attach rates on ServiceNow 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 NETGEAR and took a look at the market, call it, 3 years ago.

So what we're expecting is, it might be a little bit lower, but a relatively consistent level of both attach rates and churn as 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 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 we're forecasting for 2023.

Okay. And then a year ago, you had been talking about how the consumer is not really aware of your brand and now forward of the year, you're talking about pricing, capturing, sounds like market share. Is this coming because of the price points? Or is this coming because of your competitor having issues from management changes and pricing issues as well?

Yes. I would say it's mostly coming from just a change in consumer behavior and us 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 becoming more of an early part of the mass market, where if you can bring down at the right time, some of those entry price points, still get them subscribed and have that long-term relationship, you start to tap in to a broader market. And we're -- we saw the beginning of that in Q4, and that's something we're going to continue to do in 2023.

There are no further questions at this time. Matt, I turn the call back over to you.

Thank you, operator. Arlo 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 service-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.