Business context and reporting period
Arlo Technologies, Inc. sells connected-home devices and paid subscription services supported by a cloud platform. This unaudited Form 10-Q covers the fiscal quarter ended October 3, 2021 and the first nine months of fiscal 2021; comparisons are with the corresponding 2020 periods. Arlo operates as one reportable segment.
Financial and operating results
Amounts below are in millions of dollars except per-share data, percentages, and account metrics.
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Revenue | $111.1 | $110.2 | $292.3 | $242.3 |
| Gross profit | $24.3 | $21.4 | $76.3 | $30.9 |
| Gross margin | 21.9% | 19.4% | 26.1% | 12.7% |
| Operating loss | $(15.6) | $(18.0) | $(52.9) | $(89.2) |
| Net loss | $(15.2) | $(17.5) | $(49.2) | $(86.0) |
| Net loss per diluted share | $(0.18) | $(0.22) | $(0.60) | $(1.11) |
- Revenue mix: Q3 product revenue fell 7.8% to $84.2 million, while service revenue grew 42.4% to $27.0 million. For the nine months, product revenue rose 13.4% and service revenue rose 48.0%.
- Margins: Q3 service gross margin improved to 58.8% from 48.8%, while product gross margin declined to 10.1% from 13.3%. Management attributed pressure on product margin largely to higher freight and other overhead costs. Nine-month gross margin improvement reflected stronger product and service margins.
- Cash flow: Operating activities used $32.7 million in the first nine months, versus $59.3 million used a year earlier. Investing activities provided $18.1 million, mainly from investment maturities; financing activities used $5.5 million. Cash and cash equivalents declined by $20.1 million, including restricted cash, over the period.
- Liquidity and balance sheet: At October 3, cash and cash equivalents were $166.1 million, restricted cash $4.1 million, and short-term investments zero. Current assets were $288.1 million versus current liabilities of $194.7 million. Total liabilities were $221.1 million, including operating lease liabilities; the filing reports no borrowings under its credit facility at quarter-end. Accumulated deficit was $282.0 million.
- Business indicators: Cumulative registered accounts reached 5.822 million, up 22.0%; cumulative paid accounts reached 877,000, up 146.3%. Newly reported annual recurring revenue (ARR) was $80.4 million, up 102.9% year over year.
Material changes versus prior comparable periods
- Q3 total revenue was nearly flat year over year, as service growth was offset by lower product revenue. Nine-month revenue increased 20.6%, driven primarily by services and growth in EMEA.
- Losses narrowed in both comparable periods. The nine-month 2020 operating loss included a particularly weak gross-profit result; the 2021 period also included a $9.1 million impairment charge on San Jose office-related assets.
- Cash used in operations improved year over year, but the company continued to consume cash. Management cited a $13.1 million increase in working capital used, including effects of shipment timing and supply constraints.
- Cash and cash equivalents plus short-term investments decreased from $206.1 million at December 31, 2020 to $166.1 million at October 3, 2021. Inventory fell from $64.7 million to $39.8 million.
- Common shares outstanding increased from 79.3 million at December 31, 2020 to 84.3 million at October 3, 2021; stock-based compensation and share-based awards are relevant to dilution.
Outlook, commentary, risks, and unusual items
- The filing provides no specific numerical revenue or earnings guidance. Management expected R&D expense to remain relatively flat in absolute dollars while it continued developing products and services, and said supply-chain constraints were expected to persist through 2021 and into 2022.
- COVID-19-related component shortages, manufacturing constraints, freight capacity and higher freight rates affected deliveries and margins. Freight-in expense increased 244% in Q3 and 134% in the first nine months year over year. The company reported approximately $40.3 million of non-cancelable supplier purchase commitments and a $0.7 million loss liability related to committed purchases.
- Management stated that available liquidity, the new financing agreement and market conditions were expected to meet anticipated cash requirements for at least 12 months. On October 27, 2021, Arlo replaced its maturing Western Alliance facility with a $40 million, three-year Bank of America revolving facility; no amounts were drawn as of November 10. The new facility includes liquidity and, when applicable, fixed-charge-coverage covenants.
- The Q2 2021 $9.1 million impairment followed the decision to sublease the San Jose office. The sublease is scheduled to begin February 1, 2022 and run through June 30, 2029, subject to its terms.
- Other income for the first nine months included a $1.8 million Employee Retention Credit. U.S. deferred tax assets remained subject to a full valuation allowance; the income-tax provision primarily related to foreign earnings.
- Legal matters include an ongoing derivative action related to prior securities allegations. The related federal securities class action settled for $1.25 million and was closed; the state action was dismissed. In an ITC patent case, an administrative law judge found the asserted patents invalid, but Skybell petitioned for review; Arlo said the outcome and any possible loss could not be estimated.
- Key risks include continued supply and freight disruption, dependence on third-party manufacturers and concentrated sales channels, competition and product pricing, subscription adoption, cloud-service and cybersecurity exposure, and potential further losses or financing needs. Management said it believed goodwill was not impaired at quarter-end, but a significant stock-price decline and business deterioration could lead to an impairment charge of up to $11.0 million.
Important facts for investors to verify
- Whether paid-account and ARR growth translates into recurring service revenue, cash generation, and improved total profitability.
- Whether supply constraints and freight costs ease as anticipated, and their continuing effect on product availability and margins.
- How rapidly operating cash use continues relative to the $166.1 million cash and equivalents balance, and whether the new revolver remains undrawn and covenant-compliant.
- Arlo’s exposure to major channel partners, including Verisure and Best Buy, and the status of Verisure’s purchase commitments.
- Progress and possible financial exposure in the derivative and patent proceedings, as well as the assumptions supporting the San Jose sublease impairment and any future asset impairment.
- The impact of equity awards and share issuance on dilution, given the increase in outstanding shares and unrecognized stock-based compensation.