okay thank you everybody appreciate your interest here at the William Blair growth stock conference my name is Dylan Dylan Becker the vertical software analyst here we have Matt McCray from Arlo technologies Matt thank you for joining us appreciate it and I think maybe it's a place to start the conversation there's probably varying levels of familiarity with the business and in the story right so if you were to kind of level set the conversation for those maybe newer to the business. Can you give us some context on Arlo, what you guys are doing and how you're kind of solving the smart security space? Yeah, so I'll give just a brief history on
the company. So we started actually as a startup inside of a company called Netgear, which you're probably familiar with on Wi-Fi routing, and they were looking for technologies and, you know, user scenarios that would actually drive people to upgrade their wireless routers, because people at that point weren't buying the latest routers, and they hit upon video use cases as a way to really heat up a lot of bandwidth and get people to drive upgrades so they kind of surveyed different different product ideas and came up with basically streaming cameras so IP based cameras and also in the consumer market really focused on at that time mostly battery operated cameras so they're extraordinarily simple to set up and what they what they did was actually kick off the DIY security market segment which didn't exist before so in 20 it grew so fast that it ended up being separated from the company so we spun Arlo from Nick here in 2018 and actually at that point as a public company set on transforming the company into really a services group so at that point it was mostly hardware from a company perspective making 40 to 50 points hardware margin and that's it and we noticed that this actually had a real high probability of actually becoming a great services company so we set about deploying some of the first AI based subscription services in the world in 2018 and have grown now the subscription services on security from at the time was probably about 50 000 subscribers to now over 6 million and the services we provide so if you're not familiar with the product line people typically buy a set of cameras so it's similar to ring if you're familiar with that brand and then there's subscription services on top of that that provide object detection, recognition of the actual, you know, person or vehicle, AI capabilities, as an example, in a scene description, we're doing threat assessment, and we've seen our attach rate on services actually grow quite a bit over time. So now services revenue is actually over 60% of our total revenue and we really are a services business that uses the hardware as a way to create that relationship uh with the end user so we're seeing you know last year we saw anywhere from 20 to 30 growth on the services we're seeing very fast growth on that services business is roughly 85 gross margin um and it's been absolutely transformative the company at a bottom line level from a profitability perspective perfect and i do want to get into the kind of financial
transformation of the business, but maybe if we take kind of the market as a place to start as well too, can you give us a sense on how that's dynamically changed, how kind of the smart security space, connected home has evolved, and maybe why you're seeing an uptick in adoption around devices
and the connected services? Yeah, so when I say we've transformed as a company, we also transformed the security industry quite dramatically. So if you go back 10 years plus, almost the entire market, 95 plus percent of the market was professionally installed home security and small business security. And then Arlo hit the scene. And now anywhere from 65 to as high as 70 percent of all the growth and installs happening in security is now DIY, is do-it-yourself. And about 25 to 30 percent, or 30 percent to 35 percent is now what they call DIFM. So if you look at just DIY and and you know the hardware and the actual uh devices is 8.2 billion you combine that with the subscription on top of that and you're looking at about a 25 billion dollar market that has grown from nowhere in the last 10 to you know 10 to 15 years so that's the market we primarily are in and again the biggest transition has been from DIFM do it for me or installation to DIY at the same time you're seeing the attach rate and the importance of the service layer become more and more important so and that's why you've seen our service revenue grow so dramatically there are some additional markets that we're starting to move into as well when we look to the future and what's happening in the marketplace and that's the broader smart home category you've seen you know there's smart home and home security and our thesis is actually it's going to become smart home security and people will buy smart home devices but they're going to subscribe to security that's the that's the actual subscription that people pay for every month nobody pays for smart home on a subscription basis so that recurring revenue is going to come from the security portion but it's important for the user experience to be you know capable of driving a user experience across smart home and home security and you'll see a couple others you know small business which is a huge market smart aging which we just did a small acquisition we may talk about in a little bit we just did an acquisition in that market as well and then you have the global market so you know on total you're looking at hundreds and hundreds of billions of dollars of TAM, of which we're primarily playing in about 25 billion and expanding into the rest of the next three to five years. Fantastic.
And you kind of touched on the fact of the value proposition of connecting hardware, kind of servicing and solving and giving you the opportunity for the software business, but I guess could you kind of give us a sense of the, again, that connectivity, that importance, right? Why hardware unlocks kind of the services and the software opportunity and the value that the data set that
that creates? Yeah so and so there's a there's a several aspects to this so one you know creating that physical link to the customer is one of the very important things our average lifespan of a customer is over seven years now right and that starts the first touch base we have with them is that hardware purchase so number one it's it's an investment right so the users making investment they do the installation that helps to reduce churn and it helps them to have a great user experience and they interact with our hardware and our service interface quite a bit. Anywhere from 10 to 15 times per day is the level of engagement we get. So it's a very engaging service. Second, that hardware, like you were saying, it is our physical link to the user. It's encrypted. It connects to our back end. So in some cases, we look very much like a normal SaaS company. We have very high growth service revenue, extremely high service gross margins. So it's great. We're a SaaS company. There's been a lot of talk about SaaS companies being disintermediated by AI coming in and maybe, you know, getting between and stealing some of those markets. That can't happen in our business. That physical hardware, that link we have with the end user, we cannot be disintermediated. That hardware only works with our backend and only works with our services. So in some ways, we're the best of both worlds. We have the growth and the profitability of a fast-growing SaaS company, but we have a physical linkage to those end users. And that's produced by that hardware that they physically buy and install. And we have two main businesses in Arlo. We have what we call direct and retail, which is probably what you're familiar with. People go to Best Buy, buy an Arlo package, take it home, install, and sign up for service. And we have a partnership side of our business as well, where a lot of that is actually one-to-one attached. So if that hardware is purchased and installed, There's 100% attached to that service. And again, it's all being driven off that initial hardware installation.
And you hinted at the fact that there are very attractive, if you will, unit economics here, right? Low churn, high customer LTV, I guess. How do you see that evolution playing out from a financial framework perspective? You talked about kind of the mix shift accelerating, higher margin subscription revenue, faster growth in that segment. But how should we think about that?
Yeah, so there's been a financial transition and transformation of the company as well. I'm putting up the Q1 numbers just as an example, but what you've seen is you've seen service revenue growing very quickly because of the high profit margin on that. We've seen EPS grow quite quickly, so it's been transformative to both the service revenue line and blended gross margin and obviously our operating income over time that will continue i mean part of our business model as a company is to be a highly leveraged i don't mean that from a debt perspective but we're basically 400 employees or less driving a relatively large business partnered with some of the biggest companies in the world on the channel basis and on the partner side and on the supply chain side so if you look at the expanded profitability over time you know that's been something that I think will continue if for those of you who are SaaS investors and you look at rule of 40 our score last quarter was 49 which which puts us I think in the top four public companies in the world right now as far as profitable growth so we really are looking from a financial perspective like a services business but we have that hardware layer that provides that that lock-in with with the end users and that probably drives a lot of data
differentiation as well too so as we kind of think about the data platform right not only scale but how you kind of think about for that unlocking kind of
value in context for customers over time yeah so the data the data is good for a couple couple things so one obviously we get a lot of data of what's happening in the home you're gonna you're gonna see more advanced AI and additional use cases happening based on presence detection you know are they home are they on vacation did they leave who's home who's not home what time of day is are they going to bed did they wake up there's a lot of smart home activities and general usage patterns that people want to be automated where that context and that data is extraordinarily important and we're one of the few companies in the world that actually has that right because we're being told are you home or not all the time when they arm disarm the system geofencing in the app and all that so from a user experience perspective the data puts us in a very strong position not only to generate the recurring service revenue because people will pay for security but to actually provide a better user experience across across the entire smart home and again i think you're going to see those two worlds blend together where you're going to see smart home activities augmenting security so you know give you an example somebody if somebody approaches the front door at night i can i can flash the lights right i could make a german shepherd sound like it's coming out of my sonos system you know there are ways to use the smart home capabilities to actually augment the security subscription. So data and the data that we have puts us in a very strong position to own that user experience and be able to innovate in ways others can. At the same time, the data is really important to us. And over the last six to 12 months, we've been doing a lot of work on data insights and really understanding our customers and what's happening at a much deeper level. And so we now separate user journeys depending on where they bought the product. Did they buy the product at Walmart versus Best Buy? And we can track that and provide different journeys and different promotional strategies there how many cameras do they have do they have a doorbell is it a floodlight how often do they use the product all those data insights are allowing us to actually tailor our promotions our communications and some of the features that we provide based on all those data insights that we're seeing from the field so it's improved our conversion it's reduced our churn and it's it's helping us that could be more successful from an operational perspective as well.
And I definitely want to touch on kind of the go-to-market dynamics as well too, but since we're on the topic of data, I guess a key differentiator for the platform as well is the emphasis on privacy, at least as it relates to home security and kind of personal information. How do you guys think about privacy as a differentiator in the platform?
Yeah, strangely enough, we're in the security business, and we're one of the few companies in the segment that actually really cares about data security and privacy. So for us, it's non-negotiable. We've built the company from the ground up. where our architecture believes that the data is not our data it's the user's data and we're hosting and processing it based on their request and that's just fundamentally how we've set the business up very differently than maybe an Amazon or somebody else who views it as you know their data and they can use it for advertising or you know potentially other purposes that's not us we're one of the few companies that actually has a data security and privacy committee at the board level so we have governance at the board level that looks at all the actions we take, all the things we deploy, and making sure that we're aligned to that. That has become increasingly a competitive differentiator in the market. It happens with consumers. So when they're doing research and they find out who's had security issues or who's maybe not being that clean with data privacy. There's been some things around Super Bowl ads that caused a lot of controversy recently in the space. That helps from an end user when they're making a choice. But I would also tell you in the partnership, the B2B space, it's become a substantial differentiator. So when a Comcast or an ADT or VeriShure in Europe, when some of our partners were evaluating who they would want to go deep from an architectural perspective and solution provider perspective, it's extraordinarily important for them that they know that partner will protect and secure the data, their customer data in this case, and be aligned with the best practices in the world. So it's something that was it's been in our DNA since we started the company but it's increasingly becoming I think a differentiator from a lot of
competition in the market. And you touched on how it kind of helps with the go-to-market motion but you said kind of Best Buy some of the directs also increasing kind of the partnership channel I guess how should we think about resource allocation and kind of the channel mix between direct and partners today where that was and maybe where it's going? Yeah so it's it's
roughly it depends on there's a lot of seasonality but roughly I would say 60% is coming from retail and direct when I say direct I mean arlo.com type channels and 40% from partners Kurt and I have said that between now and our the end of our long-range plan which is to get from 6 million paid subs to 10 and to get from at the time was roughly 300 now it's like 350 in ARR to 700 million in ARR that's 60% of that incremental growth will come from partners and Some of that is because of just the size of the opportunity and that it's coming later. So the retail market is relatively more mature. We're growing in that market. We're growing faster than the market is growing on that space. We're gonna capture some additional shelf share this second half as well. So we're growing and doing a great job competing there. Market's a little more mature. It's growing at kind of five to 10%. We're growing 10 to 15% when you look at it on a unit basis. The partnership opportunity is really green field. And so our first large partner was Verisher, and we've had a great success in Europe with them. But recently, we have announced ADT, Samsung, and Comcast, so three extraordinarily large and impactful partners. And I will tell you, there's more coming after that. And so that area, I think, has a higher relative growth, only because it has such a huge market potential from a household formation perspective for us, and that it's in an earlier stage, and we seem to be the number one partner out there. partially because of the data privacy also because when we people look at our technology stack and our AI capabilities and they do any head-to-head matchups we
tend to win all of those and it's probably a good segue to the competition question right obviously we talked about why partners are kind of choosing you but how should we think about the competitive landscape more broadly and any kind of statistics you have around win rates kind of mix shift anything
anything on that yeah there's unfortunately there's not a lot of great data in the retail anymore because a lot of reporting's not happening. Serkana has some data but not all. You know the competition for us is really in in two buckets I would say. One is the the kind of bigger company brand name so you like an Amazon or a Google right and we see them you know Amazon is aggressive in some areas they can't operate in other areas like Walmart and some other areas so we've got some really good strategic partnerships in the in the main channels. Google is tending to de-emphasize and treat this area as more of a platform play, so we see them starting to pull back a little bit. And then the other bucket is kind of low cost, I would say more non-subscriber based low cost, and we see some consolidation maybe happening there. Competition in the retail and direct space really hasn't changed much in the last two or three years, except that we've had some success and I think we'll see some consolidation over the next couple years. On the partner side, we're Number one, I think we are out front both because of our culture and the way we approach data privacy and the sophistication of our back end and the services we provide. And I think we will continue to capture more than our fair share in that space. I'm not aware at this point of an opportunity that's come to our desk that we didn't win on that side. I think that will continue.
And you touched on the healthy kind of, I think, consumer unit economics. and I think you said one-to-one attached within the partner channel, but any kind of sense in how that evolves with partners of, again, maybe a higher propensity, higher ARPU, better attached on subscription services, because it feels like not only is there more white space, if you will, and a captive audience to go against, but the attractiveness of that persona or that user profile also is valuable to the business.
Yeah, so they typically have low return. So if you look at our two business segments, Because the way we look at it is retail will have higher ARPU, and then it has CAC, it has our customer acquisition costs, and then we have support costs and other things, but it's a higher ARPU, and then we net out to the numbers you're seeing there, which are obviously very good. On the partner side, you'll see a lower ARPU, but our CAC is typically zero, right? So the partner in that case is taking all the sales and marketing costs, all the support costs, right? And our goal as a company is to be relatively agnostic between the two, so that at the bottom, when you look at it like the operating dollar perspective or operating margin perspective that we should be relatively agnostic between the two at the bottom line and then that allows us to then push either or both out to the marketplace so at the top level we want to address as many households as possible we think the partnership area is a way to capture substantial household formation and it can be just as possible as the other side with lower risk lower churn even though it has lower ARPU because there's no CAC. So that's the idea. If you look at a Comcast as an example, they have 31 million broadband households in the United States. We will become Xfinity home security solution for them next year. We're in the middle of integration with them. And so even relatively small penetration is a sizable increase in paid accounts for us and can drive some significant service revenue.
Sure, especially relative to kind of the 6 million subscribers today, yeah. yeah okay that's a good I think stepping stone for the growth algorithm right I guess maybe if I think about kind of three pillars correct me if there if there are others but adding households whether director through partners cross selling additional cameras and modules and then converting services off of the existing base as well too how should we think about kind of the inputs within
each of those yeah so so they're all important I would say today when I look at the bulk of new household formation, or new subscriber formation, let's say, it's coming from new households. And that's because the market penetration is still only about 20%. So even in the retail and direct business, the next 30 million households are going to come online in the next, call it three to four years or so. So there is still a tremendous amount of households to capture. And we're still, I would say, maybe, you know, if you're using baseball analogies, maybe we're just entering the third inning or something, there's a lot of market potential just in the United States. And if you look globally, it's even behind that. So penetration globally is anywhere from seven to maybe 14 percent. The United States is just cresting 20 percent. So partnerships like Walmart, which is really important to us, is one of the ways that we're going to grow and drive some of that. As the technology segment becomes more mass market, people are going to be looking for solutions from walmart and they're one of our fastest growing partners as an example so i would say still new household formation whether that's three partners or in the direct channel is still a bulk of it we do optimize around upselling existing customers and a lot of other things i think we do that better than anyone we're doing a lot of data insights and driving that but because we're still in the early days of the market and there's still so much growth out there the bulk of new household and then subscriber formation is coming from new customers coming
into the market segment okay in from the conversion opportunity as well to households that have kind of devices the ability to kind of sign them up for recurring services is that an area of emphasis I guess yeah yeah yeah so so if
you look the way we the metrics we really pay attention to every every every every day at this point is a unit sales on the hardware right so that's what I was talking about a lot of new hardware sales going out sometimes it's partner sometimes it's an existing subscriber buying a new piece of hardware but a new hardware device going out that puts them in the top of our subscription funnel right we then look at what's the initial conversion rate and that what we measure that is did the person subscribe to a service tier within the first 30 days of that free trial ending that's our conversion rate then we follow those cohorts for six months and we call that our attach rate so we're doing a lot of work around data insights and AB testing around okay what's going on on conversion how do we boost conversion of existing subs and new subs coming in we've done a lot of work on what does conversion look like on different types of products different retail channels different partners and and that is to all not only boost conversion but also boost the lift from conversion to attach typical conversion is anywhere from 40 to 50 percent right out of the gate so that's in that first 30 day period and then we see that grow anywhere from 10 to 15 percent more as we follow that cohort out to six months and then it goes from there. So about two-thirds, you know, on kind of the top level over time, subscribe. Average subscriber is over seven years. And then our churn is about 1% per month. So we have one of the lowest churn rates of any consumer subscription service in the world. And I would
think that as you add more devices, you get more conversions, obviously drives the value of that customer and the stickiness of that customer. But as you think about compounding the data set beyond kind of home security. I know you guys just made a recent acquisition into the broader home health space, but maybe the evolution of what that data set can unlock from an incremental kind of monetization perspective. Yeah, so it's
it's a that's a very long discussion. So we're we have a user base now of you know over six million subscribers. Actually active households are over 10 million and and like I said I think the smart home and home security are coming together. So one of the first steps of us leveraging that data will be into new use cases, new user experiences going into next year with the capability of potentially new subscription services and features that drives either higher conversion or higher ARPU. So that's one way we're going to use that data to actually leverage into some exciting new capabilities that will drive incremental revenue. But you brought the acquisition of Allocare up. So recently we bought a small company in the age and place area and that, you know, From a demographic perspective, this is gonna be an area of huge growth. The market in the United States alone is about 24 billion right now. We'll grow to nearly 300 billion in less than 10 years. So you're looking at a CAGR of 25 to almost 32%. It is one in dire need. You're looking at ARPUs of 50 to $60 per month. And it's an area that fits right into our vision and mission of keeping people safe and secure. You look at the cross-sale opportunities of you know our six million we think there's an opportunity there ultimately we want to serve and create a safe and secure life for our users for basically their entire lifespan and this helps us extend that out where some of our customers will be caregivers for moms and dads we'll have some of our customers now will be starting to age in place as they go along ultimately where we want to get to is there's a set of devices that can be deployed by a partner or through retail and then there will be a set of subscription services you can bring on to create different value propositions whether that's security or aging in place home health care or some other areas that we'll be working on over time so this adjacency is a small acquisition in a huge market that's gonna be growing at an extremely fast rate and it's a market that's relatively antiquated fragmented and it really hasn't had much disruption so So our goal is to do in the age-in-place market what we've already done in security and have a complete change of the go-to-market and the unit economics.
And it definitely kind of, I think, validates the fact that we're not in any shortage of opportunity for the business, right? If I think about kind of the long term, we talked about the mix-shift dynamics, but the long term kind of financial profile. You guys had a 27 framework, if I'm correct, right? And you've executed against that and are beyond kind of those targets as of the end of 2025, if I'm not mistaken. and I think you have a longer term kind of a new target framework I guess could you kind of give us a sense of your vision maybe the next five years for
the yeah this looks like so we we we try and give investors view over a couple timeframes so we always obviously provide you know the quarter what we think is happening you know either in the quarter or the next quarter we talk about the full year and what's happening over the next 12 months we often give a long-range plan out to users and we our first one we gave out I think in 22 or 23 and they're typically five-year plans and within a couple years we had we had already beaten uh most of the metrics were on a clear trajectory where where we had investors come to us and say it looks like it's actually limiting uh what your future growth will be because you've already out executed the first couple years so we so about two years ago we we put out a new one uh that goes through 2029 the end of 2029 and the goals i mentioned before is 10 million subs 700 million in ARR and over 25% operating margin as a company. So you can think of like, what would a company be worth if they could hit those metrics? It is clear, especially after this last quarter, that we're on a trajectory to probably obliterate that as well. And so we're starting to hear from investors that again, it's looking like that long range plan, which seemed audacious when we first rolled it out a couple of years ago, is probably feels a little limiting, especially with some of the things that we're planning for growth into 27 some of the partners we've signed up so i think over the course of this year we're likely to update that long-range plan again and probably put out either new targets or bring in some of the dates of when we'll accomplish that the good news is the management team and the company we've had a demonstrated capability over the last five years of setting relatively aggressive targets beating them relatively quickly and then resetting where we think we're going to be able to achieve you said it i mean there's no shortage of growth and much of what we're doing from a capital allocation perspective inside the company is deciding where based on the capital we have to place specific bets there's no shortage of bets to be placed there's no shortage of 50 billion dollar markets all around us really what we're focused on is what are the smartest bets for shareholder return over a given time frame and those time frames are typically 12 to 24 months
and then on our our five-year plan and how do you kind of balance those decisions right because there's a lot to go after you're generating cash the margins expanding um maybe kind of the prioritization between reinvestment organically back into the business obviously we've seen some targeted m a and i do think you guys have a buyback authorization as well too so kind of
the blend between the three yeah so briefly i know we're getting close on time is um our capital allocation plan is the typical three-tiered or three-pillared capital allocation plan we're doing a buyback i would tell you the the overall sentiment in the company is we're habitually undervalued so um we had 50 million dollar buyback that was put in place uh prior that finished i think towards the end of the year just the beginning of q1 the board immediately put in another 50 million dollar buyback plan so we will be buying stock especially when we feel like it's our stock price is not reflective of the performance that we're putting out there two is uh investments or acquisitions we've done our first small acquisition we've told investors for the last couple years that if we do an acquisition and it's an adjacency we'll make a smaller bet to make sure that we don't get distracted off our long-range plan if we do one that's more market consolidation that we would go a little bit bigger but we made our first acquisition we're always going to be really smart about how we do that and very disciplined and then the third pillar is the organic investment you've seen some of that last year we launched nearly 200 skews in a big product reset last year there's some really exciting ai and new service features coming this year and we're telling investors to expect another big product technology and service deployment uh next year as well so we are investing in some of those areas it's a balance um i think you know obviously when the stock price is where it's at you'll see the the buyback kind of come up uh even more but i think we're doing a great job at balancing both the organic and inorganic investment where we're executing on a fast growing market, but not shy of making some small bets and some tactical adjacencies that we think are going to be really important over the next five to ten years. Fantastic. I think that's a
perfect teaser to continue the conversation upstairs in the breakout. Matt, thank you very much. Appreciate it. Yeah, appreciate it. Thank you. We'll be in Jenny.