Arlo Technologies, Inc. (NYSE:ARLO) Q4 2023 Earnings Call Transcript
Arlo Technologies, Inc. (NYSE:ARLO) Q4 2023 Earnings Call Transcript February 29, 2024
Arlo Technologies, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good afternoon, ladies and gentlemen. Thank you for standing by. At this time, I would like to welcome everyone to the Arlo Technologies’ Fourth Quarter and Full Year 2023 Earnings Call. All lines are in a listen-only participant mode. Later, we will conduct a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Tahmin Clarke. Please go ahead, sir.
Tahmin Clarke: Good afternoon, everyone, and welcome to Arlo Technologies' fourth quarter and full-year 2023 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 overview provided by Matt, and followed by a review of the financial results by, Kurt. Matt, will then share an update on technology and innovation, and Kurt will deliver guidance for the first quarter and full-year. Then we'll wrap up with Matt, providing an update on the long range targets, and the team will then answer any questions that you may have. 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 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 first quarter and full-year of 2024, long range targets, the rate and timing of paid subscriber growth, the 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, partnerships with various market leaders and 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 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.
Matt?
Matthew McRae: Thank you, Tahmin, and thank you everyone for joining us today on Arlo's fourth quarter and full-year 2023 earnings call. Two years ago, Arlo unveiled our long range plan to provide visibility into our forward operational goals and to set clear goalposts for investors to measure our transformation and acceleration into a services business. The team's stellar performance of the last two years has put Arlo on a trajectory to surpass those targets. Our business has clearly hit an inflection point that warrants us updating our long range plan targets to more accurately convey where the business is headed and set newer and higher goal posts for us to focus on. As part of this long range planning process refresh, we evaluated our execution from Arlo's IPO in 2018 to where we stand at the end of 2023.
I would like to share some highlights of that review before we get started today. First, let's take a look at our paid accounts, the underlying growth driver of Arlo's transformation. At our IPO, we had just over 100,000 subscribers that were a result of a 5% service attach rate. I remember standing in front of the entire company at the time and saying our first goal was to hit 1 million subscribers. Given the fundamental change required in technology, operations, and culture, it seemed an almost insurmountable goal. Since then, we have increased our paid accounts 25 fold and more than doubled our subscriber base since we rolled out our long-range plan in 2021. It is a similar story for annual recurring revenue, which has shot up 16 fold since our IPO and, again, has more than doubled since the rollout of our long-range plan to reach $210 million.
And finally, a quick look at non-GAAP operating margin, which has swung more than 12 percentage points since our IPO, and is continuing to expand since hitting the 2 million paid account number. This was not an easy journey. Transforming a public company from the inside out without raising capital or taking on debt was an extraordinarily difficult task that required belief, discipline, and best-in-class execution. I would like to take a moment to thank the entire Arlo team for their hard work and dedication to our customers, suppliers, and all our stakeholders. Arlo is so focused on where we are headed that it is easy to forget how far we have come. We have achieved an incredible feat, and I look forward to climbing the next mountain together.
So, who is Arlo now after this transformation? Arlo is a service business providing consumers and small businesses peace of mind by connecting and protecting everything that matters to them. We have a core belief that everyone has a right to feel safe and in control of their lives. The entire company is built around fulfilling this need. Arlo users have an emotional and personal connection to their use cases, which transcends a typical transactional or one-time engagement. I learned early on that we play an extremely important role in our users' lives. And by providing this value to them every day of every week of every month, we can become a trusted companion that becomes a part of their daily life. And the need is large and growing. People feel less safe as they see and experience a rise in burglaries, theft, and assault.
Property damage from fire and water leaks have grown to nearly $50 billion a year in the U.S. alone, creating a huge burden on families and insurance companies. These are large problems with a massive impact in both life and financial terms that if properly addressed could increase the quality of life and drive significant savings to numerous industries. These trends are driving substantial growth in our market. Offerings that can detect, control, and mitigate these negative events are seeing rapid growth that will ultimately grow to a $50 billion market by 2027. Arlo is leading a wave of innovation that is bringing these capabilities to mass market consumers through simple, elegant, innovative, and powerful solutions available through numerous channels.
This leadership has propelled Arlo's New York rise in annual recurring revenue and our recognition as a world class SaaS business. The SaaS ecosystem is filled with well-known companies. In fact, we studied the business models of our best-in-class peers as we set about building a world class services focused company. Our execution after launch puts Arlo in rarefied air when looking at how fast a SaaS company reached the critical $100 million of ARR milestone. Only a handful of companies have achieved this feat in five years, and Arlo is the most recent example. What is driving this success is our retail and direct paid accounts, which represents a majority of that service revenue and ARR. Our average revenue per user is now over $11 per month or $135 on an annual basis.
And this business is operating at nearly 90% gross margins. If we look at these users on a lifetime basis, the customer lifetime value is roughly $700 while our acquisition cost for that customer is $100. This results in an LTV to CAC ratio of seven. How does that compare with other world class SaaS companies? Again, you can see that Arlo service business is operating at an extremely high-level when compared to the top peers in the industry. Our LTV to CAC ratio of seven puts us above some of the largest and well known SaaS companies in the world and well above the industry average of three. This also illustrates we have significant room to invest in customer acquisition to further drive growth in ARR and shareholder value. Underpinning that impressive LTV number is another world-class metric, our churn rate.
Arlo experiences a churn rate of between 1.1% and 1.3%, which stands apart from the top consumer SaaS businesses in the world. This churn rate has held across the pandemic, price increases, and macroeconomic challenges and is evidence for the depth of the value Arlo provides our users, how peace of mind is so sticky, and the importance of the role we play in our users' lives. Recently, Arlo was awarded the IoT Security Camera of the Year Award by the Tech Breakthrough Organization. This award honors companies based on innovation, creativity, hard work, and ultimately, success on a global basis in the IoT and smart home markets. And Newsweek selected Arlo as a winner of its Excellence 1,000 Index for 2024, which recognizes companies based on their commitment to best practices and growth while serving customers, stakeholders, and communities with a dedication to social responsibility and ethical standards.
Arlo was ranked number 14 out of 1,000 global companies and was placed in the top five for the IoT category, an honor we share with Intel, Nokia, Verizon, and Microsoft. Arlo is a world-class company punching well above our weight and focused on leading the market through innovation and disciplined execution of our operating plan. And now, I will turn it over to Kurt, who will provide an overview of our Q4 and full-year 2023 results.
Kurt Binder: Thank you, Matt, and thank you, everyone, for joining us today. 2023 was an outstanding year for Arlo as we continue to advance our track record of operational excellence guided by our services-first strategy. Our approach has yielded significant paid customer additions, best-in-class lifetime value per subscriber, and a record level of services gross margin. And this year, we achieved a critical inflection point. For the first time ever in our history, our services business gross profit exceeded our non-GAAP operating expenses. We expect this trend will continue even with acceleration in paid accounts and promotional activities to drive new household formation. This positions Arlo well for continued growth and profitability, and we are just beginning to tap into the vast long-term opportunity.
Before we address the long-term growth potential of the business, let's discuss the financial details around Q4 and the full-year 2023, which will provide context for why we are so excited about the future. Total revenue for the fourth quarter came in above consensus at $135.1 million up 14% year-over-year, driven primarily by the strong growth of our services business. The revenue derived from products was in-line with the prior year period and driven by the successful launch of the Essential 2 product line. While the ASPs for our products declined as a result of our commitment to our pricing strategy, unit volume was higher demonstrating strong demand for our products and services. Revenue for the full-year of 2023 was $491.1 million in-line with the prior year and within our original annual guidance range.
Our strategic shift to a services-first operating model was evident in the growth of our total subscribers, which increased by 51% year-over-year to 2.8 million paid accounts at year-end. This paid account growth was instrumental in driving our year-end ARR up by about 53% year-over-year to $210 million. Our focus on subscriptions has provided a major uplift in our profitability, while also creating greater visibility and predictability and meeting our near-term revenue targets, while dampening the volatility around consumer sentiment and other macroeconomic factors. Our service revenue for Q4 was another record at $55.9 million, an increase of $17.6 million or 46% year-over-year, driven by strong paid accounts and a price increase which occurred earlier in the year.
Our service revenue for the full-year of 2023 was $201.2 million, an increase of $65 million or 47% year-over-year fueled by the addition of almost 1 million paid accounts during the year and a robust install-base. While service revenue accounted for 41% of our total 2023 revenue, it represented about 87% of our total gross profit, highlighting the value inherent in the subscription-based model that Matt discussed earlier. This also enabled us to be profitable just based on the services gross profit, again, providing a level of stability and predictability we did not have a year ago. Product revenue for Q4 was $79.2 million, which is in-line with the revenue generated both in the previous quarter and in the prior year period. Our product revenue for the full-year of 2023 was approximately $290 million, down 18% year-over-year as a result of our shift in pricing strategy and constrained inventory levels in the EMEA region.
Despite the decline in product revenue, the number of devices we shipped worldwide was up 5%, highlighting our strategy to drive household formation and to bring additional paid customers into the Arlo ecosystem. During 2023, our international business generated 39% of our revenue. And for 2024, we expect our international customer base to continue to be a meaningful portion of our revenue. Our EMEA revenue was down year-over-year, primarily driven by our largest customer, Verisure, and their desire to reduce inventory levels and related carrying costs. Based on current visibility and forecast, we expect that Verisure’s inventory procurement activities will resume to more normal levels in early 2024. Our ability to develop such a strong and collaborative relationship with Verisure has proven to be a great foundational element in Arlo's success.
From this point on, my discussion will focus on non-GAAP numbers. The reconciliation from GAAP to non-GAAP figures is detailed in our earnings release that was distributed earlier today. Our non-GAAP gross profit for the fourth quarter was $48.3 million, up $15 million or 46% year-over-year, driven by the improvement in service profitability. This resulted in non-GAAP gross margin of 36%, up almost 800 basis points from 28% in Q4 of 2022. Our non-GAAP gross profit for the full-year of 2023 was $171.7 million, up 22% year-over-year. This resulted in a non-GAAP gross margin of 35%, up more than 600 basis points from 29% in 2022. The $31 million year-over-year increase in non-GAAP gross profit was primarily attributable to the growth in revenue and improvement in gross margin percentage in our service business, as well as bolstered by the price increase that we implemented earlier in the year.
This was also driven by continued modernization of new customers that we bring into our service plans, coupled with an ongoing focus on cost optimizations. Non-GAAP service gross margin for the full-year was 74%, significantly up from 67% in 2022. Non-GAAP product gross margin for the full-year was 8%, down from 14% product gross margin reported last year, which is consistent with our strategy to leverage product margin to lower the cost of entry into the Arlo ecosystem and generate additional service revenue. Total non-GAAP operating expenses for the fourth quarter were $38.5 million up about $3 million sequentially and $1.4 million year-over-year, which is in-line with our expectations. Total non-GAAP operating expenses for the full-year of 2023 were $146.7 million in-line with the $146.9 million reported in the same period last year.
Our ability to report full-year operating expenses at the same level as the prior year truly demonstrates the leverage in our business model. We showed extraordinary leverage in our service business, as service revenue rose by $65 million, while the cost to deliver that revenue only grew by $7 million. This represents an 89% gross margin on the incremental service revenue added in 2023. In Q4, we posted non-GAAP operating income of $9.9 million and non-GAAP net income of $11 million. The non-GAAP net income was up almost $15 million when compared to the prior year period. Our non-GAAP net income translates into net income per diluted share of $0.11, well above the Q4 consensus of $0.08 per share. For the full-year of 2023, we reported non-GAAP net income of $27.8 million, up more than $33million when compared to the full-year of 2022.
Our non-GAAP net income translates into a net income per diluted share of $0.28, again, a significant improvement year-over-year from the net loss per diluted share of $0.07. The improvement in non-GAAP net income was driven by a combination of services revenue growth and gross margin expansion coupled with a disciplined approach to cost management. You can expect us to continue to be focused on managing the operating expenses, to invest in growth opportunities ahead of us, while delivering maximum profit to the bottom line. Perhaps the most impressive benefit of aligning every part of our organization to this services-first approach is the improvement in free cash flow. During 2022, Arlo's free cash flow was a negative $48 million. While in 2023, Arlo generated positive free cash flow of $35 million.
That's an improvement of $83 million in cash flow in a single year. And when coupled with the increased level of profitability, it is transformational for Arlo. Regarding our balance sheet and liquidity position, we ended the quarter with $136.5 million in available cash, cash equivalents and short-term investments. This balance was up over $10 million sequentially and almost $23 million year-over-year, underscoring the improving profitability Arlo is generating. We expect our cash generation to continue due to the operating leverage from the subscription model. Given our growing cash balance, we are extremely focused on our ability to allocate capital in ways that generates the best return, whether it be investing in the business to spur organic growth, acquiring assets that will complement or accelerate our future growth and profitability, or returning capital to shareholders.
Our DSO levels for the quarter decreased to 44 days in Q4 of 2023 as compared to the prior quarter and the same quarter last year, driven by the volume of essential two cameras shipped in the early part of the fourth quarter, as well as our enhanced collection efforts on our base of large retail customers. We will continue to monitor our DSOs closely, but we are pleased with the overall status and collectability of our outstanding receivables. Regarding inventory, we increased our inventory levels in the third quarter to $53.5 million to meet the expected consumer demand in the fourth quarter, as well as in support of the largest product launch in company history with the Essential 2 camera lineup. During Q4, we had already substantially reduced our inventory balance to $38.4 million with inventory turns improving to 7.6 times down from 5.5 times in Q3.
That inventory improvement was driven by a well-executed expansion of our Essential 2 product lineup into the mass market retailers like Walmart and Amazon to support their larger fourth quarter annual promotional events. And now, I'll hand the call back over to, Matt.
Matthew McRae: Before we move on to our outlook and the updated long-range plan, I would like to provide a glimpse into innovation at Arlo and our planned technology pipeline that will serve as a key component of our future growth strategy. Innovation is at the core of what we do. Arlo invented the wire-free security market with our original camera that launched nearly a decade ago. That innovation expanded to industrial design, low power intellectual property, RF designs, and numerous industry-first product launches as we drove the category forward. Arlo also revolutionized the market by being the first company to provide AI-based subscription services back in 2018, well ahead of the broader AI cycle we see today. Arlo services are built on our best-in-class platform, which is one of the largest highest performance security and AI platforms in the world.
It is performing billions of AI predictions on millions of hours of video per day across thousands of parallel compute clusters in real-time. We are adding new recognition engines, a predictive capability, more context awareness, and personalization capabilities to support the new Arlo Secure user experience. Our platform is a core differentiating asset that we continue to invest in, providing clear performance superiority in the market. Our culture of innovation has resulted in the most awarded product and service ecosystem in the world. These are some of the most recent awards that touch on our technology and user experience leadership. You will notice that our trophy case has moved beyond just the technical press and into the popular media properties and content sites.
The Smart Security segment is moving beyond the early adopter market and entering the mass market phase. As such, we have turned our engine of innovation towards simplifying the user experience and making truly powerful DIY security accessible to everyone. Reviews on our new Arlo Secure app show the results of this effort. AndroidGuys said, “For first time users and those just dabbling in home security, things don't get much easier.” TechHive said, “I always enjoy the ease and flexibility Arlo Secure brings to operating the camera.” PC Magazine wrote, “Motion alerts arrived instantly and were correctly identified.” How-To Geek said, “The installation process for the camera is quick and easy, and the companion Arlo app is user-friendly and offers a seamless experience.” “The companion Arlo security app is the most impressive security-based app I have ever used.” Our focus on simplicity as we broaden our TAM to include the mass market will continue as we drive an exciting path of innovation around the user experience.
And on that note, I would like to provide a sneak-peek of our next generation security offering, Arlo Secure 5, which will begin rolling out in the second half of this year. This represents the most comprehensive and feature-rich update in our company history, and truly raises the bar for a smart security experience and service. Our new user experience has been extended to include a user customizable dashboard with master arming, support for multiple locations, configurable widgets, and smart home device control. We have also introduced powerful event feed that provides chronological timeline with intuitive search and filter features. The app also includes a powerful automation and shortcut engine, which permits the user to create simple or complex behaviors across the entire ecosystem.
And Arlo Secure has the most sophisticated and robust emergency response experience, providing direct dispatch and real-time two way status of any emergency enabled by the best cameras available. With Arlo Secure 5, we are expanding our detection engine to include fire, barking, screaming, glass breaking, and other audio or visual events. And, we are introducing a powerful and extendable recognition engine that will initially launch with facial recognition and vehicle recognition. Arlo Secure 5 will also add predictive and proactive capabilities by analyzing events and past data to suggest or improve the user experience. And over time, the service will be more situationally aware by analyzing a full scene to drive deeper insights and metadata.
And I'm excited to announce that Arlo Secure 5 can produce personalized AI experiences. This frees Arlo from having to develop numerous generic models for each potential use case and provides a nearly unlimited capability. A user simply types in a phrase or question and take snapshots of the different states. The text and images are combined into a personalized multimodal AI micromodel that can get smarter over time with further user input. And that tailored experience is completely private to that user. None of the data, prompts, resulting model, or events are shared with any other user. This is a truly groundbreaking innovation, and we look forward to what experiences our users will build. And finally, Arlo will be testing a more feature-rich free tier that includes embedded advertising.
This will allow non-subscribers to access a more powerful experience without the need for a full paid subscription. Arlo Secure has extremely high engagement and could produce up to 750 million impressions per month that could be leveraged with relevant advertisements, partnerships, or other information. The potential for service revenue growth is exciting as we would be able to monetize our entire user base for the first time. Arlo Secure 5 will be the most important and powerful smart security experience in the world and extends our lead in the industry by a considerable margin. It provides groundbreaking new capabilities with compelling differentiation for the user and the foundation for significant growth. And now, I'll turn it over to Kurt again, for a look at 2024 and our guidance.
Kurt Binder: Our strong operational performance in 2023 and groundbreaking innovations that Matt just discussed, positions us for success in 2024 and beyond. Arlo's addressable market is expanding as the value proposition that we provide can serve a broader range of customers. We were ranked as one of the top two providers of hardware for safety and security in 2023, and we are confident that we can continue to win and take market share in the future. Arlo is a pure play security company that provides a dedicated focus on protection, which our peers cannot match. Unlike others who participate in the safety and security market for unrelated purposes, like access to user data or selling non-security products and services, our singular focus remains that every person is entitled to feel safe and secure every day.
Our products are centered around video capture and intelligent processing. And given the collection of awards we have won for innovation, we are clearly leading the industry in this arena. We give users peace of mind with our safety and security pledge, a promise that their data will only be used to enhance their personal safety and that their data is exactly that, theirs. Our platform, one of the most powerful video ingress platforms in the world with more than five years of AI track experience, is the backbone of Arlo's ability to truly differentiate its service. And finally, Arlo has tailored offerings to support the entire market, delivering both DIY and DIFM solutions at every price point to meet each customer where they are in their security journey.
Safety and security is all we do. Our focus remains on accelerating our penetration of households globally. Paid account growth will deliver expanded service revenue and profitability, and this will remain the primary catalyst of intrinsic value in the long-term for Arlo. We will continually look for opportunities to expand our feature set and functionality in all aspects of our service offering. Customers will migrate to service offerings that enhance their feelings of safety and connectivity. We endeavor to create compelling service offerings that deliver those benefits. And in turn, we will continue to have pricing power that can create ARPU expansion over time. And finally, we will leverage our position as the central hub of the smart, safe home with platform offerings and data solutions that can enhance the quality of life for our customers.
We view adjacent market opportunities like InsureTech and Telehealth as impactful segments that will require advanced video capabilities, scalable platforms, and an elevated level of privacy, all of which Arlo is extremely well-positioned to provide. Our differentiation and additional growth drivers give us the confidence that we can deliver on both our short-term and long-term expectations that we will share with you today. Considering that Arlo has surpassed the 3 million subscriber milestone in the last few days, almost exactly one year after we hit the 2 million subscriber target, demonstrates how well-positioned the company is to leverage the significant opportunity available in the smart security space. Our strategy remains consistent with last year.
We will leverage our product pricing to lower the consumer's barrier of entry into the Arlo ecosystem and further fuel subscriber and service revenue growth. Bolstered by the launch of our Essential 2 product line, we are well-positioned to compete across all price bands in the market. And with the consumer environment continuing to be price sensitive, we will price strategically so we can grow unit sales and overall market share as a means to grow our subscriber count. With that said, we expect the first quarter revenue for 2024 to be in the range of $117 million to $127 million. We expect our first quarter GAAP net loss per share to be between $0.08 and $0.02 and our non-GAAP net income per diluted share to be between $0.05 and $0.11 per share.
For the full-year of 2024, we expect revenue to be in the range of $510 million to $545 million factoring in our cautious outlook around consumer sentiment. We will use our innovative service offerings and pricing levers to continue to drive ARR growth and remain focused on exercising cost discipline to expand our profitability. We expect that our service revenue will grow at roughly 20% year-over-year and that non-GAAP service gross margin will be in the range of 75% throughout the year. And finally, we expect our non-GAAP net income per diluted share to be between $0.35 and $0.45 per share.
Matthew McRae: At this point, I would like to revisit the slide that started this call today. The company that is in front of you today is fundamentally a different entity. Arlo is a subscription-driven consumer services business with world class SaaS level metrics driven by innovation and entering a mass market that provides significant upside for growth. Our performance since IPO reflects this, and our performance since recently rolling out our long-range plan shows the business has hit an inflection point and is ready for further service revenue and profitability expansion. As a result of this outperformance, coupled with the highlighted growth drivers, we are confident that we can sustain this operating momentum over the long-term.
Our long-range plan metrics we published in March 2022 seemed bold at the time, but our current trajectory and recent success have turned them into a foregone conclusion. It is not in Arlo's culture to coast to the finish line, so we are choosing to reset our long-range plan to metrics that reflect the scale of the opportunity in front of us. That high-degree of confidence allows us to share our long-term outlook for the business through 2030 with a focus on the same key operating metrics previously shared. By year-end 2030 or earlier, we expect that we can deliver 10 million paid subscribers, $700 million in annual recurring revenue, and 25% operating margins. These new goals represent a threefold to fivefold increase from our current results and will be achieved through both organic internal investments and potential inorganic growth opportunities we will speak more about in the coming quarters as we finalize our capital allocation plan.
Arlo intends to take advantage of the market dynamics and our leadership position to drive growth well above our current trend line, which reflects the confidence and excitement we have in our future. And now, I'll open it up for questions.
Operator: Thank you. [Operator Instructions] Your first question comes from the line of Scott Searle from ROTH MKM. Please go ahead.
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