Arlo Technologies, Inc. — Q3 2018 Form 10-Q
Reporting period: Fiscal quarter ended September 30, 2018; comparisons are with the quarter ended October 1, 2017. The financial statements are unaudited. Arlo completed its IPO in August 2018 and began operating as a standalone public company; historical results include allocations from NETGEAR and may not reflect standalone costs.
Business context and performance
Arlo sells connected cameras and other smart-home devices through retail, wholesale and carrier channels, alongside cloud and subscription services. As of September 30, 2018, it reported approximately 2.5 million cumulative registered users and more than 10 million devices shipped since launch. NETGEAR retained approximately 84.2% of Arlo’s shares and said it intended to distribute its holdings before the end of Q1 2019, subject to approvals and other conditions.
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $131.2m | $104.9m | $342.8m | $245.9m |
| Gross profit / margin | $29.7m / 22.7% | $28.4m / 27.0% | $87.1m / 25.4% | $61.4m / 25.0% |
| Operating income (loss) | ($13.4m) | $5.7m | ($35.2m) | $3.0m |
| Net income (loss) | ($13.2m) | $6.0m | ($36.4m) | $3.9m |
| Net income (loss) per diluted share | ($0.19) | $0.10 | ($0.56) | $0.06 |
- Revenue grew 25.1% in Q3 and 39.4% for the first nine months. Management attributed growth primarily to Arlo Pro 2 and Arlo Lights launches and continued demand. Service revenue increased 25.9% in Q3 to $9.8m and 34.7% for nine months to $27.1m.
- Devices shipped rose 31.5% in Q3 to 1.421 million; cumulative registered users increased 87.5% year over year to 2.498 million.
- Q3 gross margin fell 4.3 percentage points year over year, principally because of higher channel marketing promotions; stronger product margins, including from Arlo Pro 2, partly offset the decline. Nine-month gross margin increased 0.4 percentage points.
- Operating expenses were $43.1m in Q3, including $5.8m of separation costs; nine-month operating expenses were $122.3m, including $23.6m of separation costs. R&D and G&A increased substantially year over year, reflecting investment, standalone-company costs and transition services.
Cash, liquidity and obligations
- At September 30, 2018, cash and cash equivalents were $148.1m and short-term investments were $39.8m; total current assets were $474.6m and current liabilities were $196.4m.
- For the first nine months, operating cash flow was negative $46.3m and investing cash flow was negative $50.6m, including $39.8m of short-term investment purchases and $10.9m of property and equipment purchases. Financing cash flow was positive $244.9m, principally from $173.4m of net IPO proceeds and NETGEAR funding. Ending cash was $148.1m.
- The filing reports no conventional borrowings. It records $21.6m of financing lease obligations related to the San Jose headquarters build-to-suit lease. Non-cancelable supplier purchase commitments were $44.9m; disclosed operating lease commitments totaled $10.8m.
- Management believed available liquidity would cover anticipated requirements for at least 12 months, while noting that future needs could require additional financing. Inventory rose to $132.5m from $83.0m at December 31, 2017; inventory turns declined to 3.1 from 4.6 at year-end. DSO was 81 days, versus 115 days at year-end.
Outlook, commentary and risks
- Management expected losses to increase in Q4 2018 due to seasonal promotions, efforts to grow registered users and remaining standalone separation work. It forecast $6.0m–$7.0m of Q4 separation-related expense, with IT infrastructure and ERP implementation among the significant costs. No specific revenue or earnings guidance was provided.
- Management expected R&D, sales and marketing, and G&A costs to rise in absolute dollars as Arlo invests in products, services, marketing and standalone operations. It expected devices to remain the majority of revenue for the foreseeable future, while subscription revenue grows.
- ASC 606 was adopted January 1, 2018 using the modified retrospective method; prior-year comparisons were not restated. For Q3, reported revenue was $3.2m lower and reported net loss $3.0m greater than the figures that would have resulted without ASC 606, principally reflecting the timing and presentation of channel rebates, discounts and other liabilities.
- Key risks include intense competition and pricing pressure, reliance on a limited number of retail and distribution partners and third-party manufacturers, product quality and cybersecurity risks, dependence on Amazon Web Services, foreign-exchange exposure, and the costs and execution risks of separating from NETGEAR. A 10% currency movement was estimated to affect pretax results by approximately $2.1m. The filing identifies potential U.S. tariffs on certain Chinese imports as a risk.
- The planned NETGEAR distribution was not assured. Tax-related restrictions could constrain certain transactions, and Arlo could owe material indemnities if the separation or distribution failed to qualify for intended tax treatment. Management reported no legal proceedings expected to have a material adverse effect and no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether revenue growth converts into improved gross margins and sustainable profitability, given Q3 margin contraction and expected continued spending.
- Whether cash use, inventory levels and supplier commitments remain manageable as seasonal demand and product forecasts evolve.
- Actual standalone operating costs after NETGEAR transition services end, and progress and spending on IT and ERP systems.
- Timing and completion of NETGEAR’s proposed share distribution, and the resulting ownership, trading supply and tax implications.
- Exposure to major retail channels, AWS, manufacturers, tariffs, cybersecurity events and foreign-exchange movements.
- Effects of ASC 606 estimates and the company’s tax position, including the full valuation allowance and $1.5m of unrecognized tax benefits and related interest and penalties.