Arlo Technologies, Inc. Q2 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. I would now like to turn the conference over to Erik Bylin. Please go ahead, sir.

Thank you, Eric, and thank you everyone for joining us today on Arlo's second quarter 2021 earnings call. Our team again outperformed our expectations while navigating the considerable supply chain challenges that many companies are currently facing. With the excellent second quarter performance, we continue to see acceleration across key metrics; product revenue, service revenue, and total revenue for the quarter were all up 48% year-over-year. Total paid accounts were up 133% year-over-year and non-GAAP gross profit dollars were up an incredible 328% year-over-year. Our strategic shift towards services, the success of our new business model, and the resulting transformative improvement in our profitability are undeniable. While we expect these supply chain challenges to continue in the near term, we see continued strong demand and are reconfirming our expectations for the full year. Revenue came in comfortably above the top end of our guidance at $98.6 million. Q2 marked the eighth consecutive quarter of record service revenue at $25.3 million. The strength in our services business, coupled with double-digit year-over-year revenue growth in the Americas and Asia-Pacific and triple-digit year-over-year revenue growth in EMEA, drove a non-GAAP gross margin of over 18% year-over-year. This strong performance led to significantly outperforming the high end of our guidance for non-GAAP net loss per share, which came in at a loss of just $0.04. Our cash, cash equivalents, and short-term investments balance increased by $1.6 million during the quarter, landing at a healthy $178.7 million. We have lowered our non-GAAP operating loss by an impressive 86% year-over-year in the first half of 2021, from a $52.3 million loss in 2020 to a $7.4 million loss in 2021. With our current cash position, we anticipate reaching profitability without the need to raise additional capital. In Q2, we added 146,000 paid accounts, a record high which represents an increase of 28% sequentially and 240% year-over-year. On July 4th, we reached more than 700,000 paid accounts and believe we are well-positioned to achieve our 1 million paid account goal by our year-end earnings call. As previously mentioned, service revenue in Q2 was over $25 million, giving us a clear path to hit our projection of $100 million of service revenue for the year. As we experience tremendous growth in services, Arlo is also driving innovation to further enhance the value provided to our users. In July, we announced a major update to our service plans which have replaced Arlo Smart. Arlo Secure features computer vision-based object detection, AI-based audio detection, interactive notifications, animated event previews, secure cloud storage of video up to 2K resolution, 24/7 premium support, and 10% off Arlo.com purchases. Arlo Secure is $9.99 per month and now supports an unlimited number of devices. Arlo Secure Plus includes all of the features from Arlo Secure, increases the resolution of cloud video storage to 4K, and includes our Arlo's new 24/7 Emergency Response, providing a new level of assistance when every second counts. A single tap allows the user to request specific emergency resources to be immediately dispatched with a choice of fire, police, or medical. Live trained Emergency Response agents will assist by providing continuous updates to users and first responders via their preferred method of communication. The new Arlo Secure service plans extend further Arlo's technology leadership while providing significant value to our users. Our industry-leading technology continues to outclass the competition on the hardware side as well. Since our last earnings call in May, Arlo's Pro Four Series won the Editor's Choice Award from Tech Hive, and several Arlo solutions are featured in best of 2021 lists across the industry. Finally, I would like to update you on our strategic partnership with Verisure. We're excited to share that the new camera system designed specifically for their security channel was successfully moved into production in Q2, and we expect initial field rollouts in Europe in the second half of this year, with full volume deployments in 2022. That success led to current quarter revenue in Europe growing 123% year-over-year, and we expect Europe to deliver more than $100 million in 2021 for a growth rate of more than 60%. And now, I would like to hand the call over to Gordon, who will provide more insight into our financial performance, operational details, and outlook for the third quarter.

Thank you, Matt, and thank you everyone for joining us today. We delivered strong Q2 2021 financial results that exceeded our expectations, growing our non-GAAP gross profit dollars by 328% year-over-year, while revenue was above the high end of our guidance and up more than 47% over Q2 2020. Our financial performance for the quarter was underpinned by the successful execution of our new business model, leading to record levels of paid accounts. The Arlo team navigated continuing tough supply challenges to exceed our expectations on revenue while significantly improving our profitability. Most notably, we decreased our non-GAAP operating loss by $20.5 million year-over-year. Revenue came in at $98.6 million, up 47.9% year-over-year and 19.4% sequentially, driven by meaningful growth in both product and service revenue. Product revenue for Q2 2021 was $73.3 million, which was up 47.8% compared to last year and up 22.7% sequentially. Our service revenue for Q2 2021 was a record $25.2 million, up 48.3% over last year and up 10.8% sequentially. During the second quarter, we shipped approximately 808,000 devices, of which approximately 805,000 were cameras. Our non-GAAP gross profit for the second quarter of 2021 was up $21 million year-over-year to $27.5 million, resulting in a non-GAAP gross margin of 27.9%. The year-over-year improvement in non-GAAP gross profit included improvements of $13.2 million from product and $7.8 million from services. Total non-GAAP operating expenses were $31.8 million, up 6.9% sequentially and up 1.6% year-over-year. We believe our non-GAAP operating expenses will be in the range of $34 million to $35 million per quarter in the second half of the year as we invest in R&D and digital advertising. In Q2, we posted a non-GAAP net loss per diluted share of $0.04, much better than our guidance and a significant improvement year-over-year. We expect third quarter revenue to be in the range of $100 million to $110 million. Given that, we expect our 2021 full year revenue to come in between $410 million and $420 million. Our team remains extremely focused on getting to breakeven on a non-GAAP basis later in the year. And now, I'll open it up for questions.

Hi, thanks for taking the question and congrats on a nice quarter. You continue to see nice growth in your subscription business, how do you think about the opportunity of your current install base who could potentially become subscribers? What is your strategy for converting these users who have already bought the product and not signed up after their free trial?

That's a great question. We are seeing subscribers come from a couple of areas: one is the partnership with Verisure and the strong growth we're seeing in Europe; two is all the new registered users that we're capturing every quarter through our normal channels; and three, to your point, we are actively tapping into our legacy install base. We do that through specific promotions for signing up to Arlo Secure and our new service plans that we announced this quarter, as well as by encouraging users to add new hardware to their existing systems, which tends to increase their likelihood of subscribing. We are refining our marketing strategies for these users and are seeing increased success quarter-over-quarter as we learn how to better engage with them.

Sure. Hi Jeff, it's Gordon here. In Q3, we're balancing revenue against profit. The supply constraints are really the story, and we are spending a bit more on air freight to get products to our customers, which is the primary reason for the slight decrease in product gross margins. There is also some cost component increases built into that.

Hi, this is Catherine on behalf of Adam. Thanks for taking our question. Can you talk about the early feedback that you've seen from your new subscription plan, Arlo Secure and Arlo Secure Plus?

Yes, we're not going to forecast going forward because it’s yet to be seen how many people actually move from Arlo Smart to Arlo Secure Plus, depending on which plan works better for them. However, early reactions have been positive. One major change is we moved to unlimited device support, which is something customers have been asking for. This simplifies the sign-up process. The other innovation we've rolled out is the Emergency Response feature, which allows users to request emergency assistance with a single tap. This is a significant advancement that we believe will add a lot of value for our customers.

Your question about our ideal inventory position is well noted. The inventory level for Q2 is pretty high, and we did see a quarter-over-quarter decrease of $13 million in our on-hand inventory. We aim to get inventory back up slightly to meet demand as we have better visibility into supply for the rest of the year. We're confident in our revenue guidance of $400 million to $420 million.

Hi. First question is, given your annual revenue guidance, it seems you are expecting more revenue from Europe. Does it matter to your end if it comes from Europe or North America in terms of revenue and gross profit dollars?

No, it doesn't matter where revenue is generated. In the current quarter, Europe was 25% of our revenue, and we expect to see consistent growth from our partnership with Verisure in Europe. We should see some nice growth in paid accounts from this channel as it gains momentum later this year and into 2022.

How comfortable are you with the supply chain to secure the necessary components to continue through Q4, given that inventory did decline sequentially?

We've been focusing on securing supply chain components, and our supply chain team has done an exceptional job. We have good visibility into our supply for the latter part of this year and are confident in our guidance of $400 million to $420 million revenue.

Hi. Thank you for taking the questions. Thinking about the success you've had with Verisure in Europe, how do you plan to replicate this in other regions?

The B2B channel, like the partnership with Verisure, is an important area of growth for us. We've also signed deals with other distributors and service providers in the U.S. and will continue to pursue additional partnerships. Our strategy focuses on driving hardware sales through these partnerships while also increasing service subscriptions, as we have a one-to-one attachment rate for our services. This is a strong growth vector for us. Thank you, operator. I want to take a moment to thank all of the teams at Arlo for their outstanding work in delivering the world's most recognized smart security system. We've launched more than 10 products under our new business model and continue to see an acceleration of our service revenue and paid accounts. I could not be more proud of our achievements as we focus on our mission to protect and connect what our users care about most. Thank you everyone for joining us today.

This concludes today's conference call. Thank you for participating. You may now disconnect.