Arlo Technologies, Inc. — Q2 2020 Form 10-Q
Business context and reporting period. Arlo sells connected home-security devices and paid cloud services. This unaudited report covers the fiscal quarter ended June 28, 2020, and the six months then ended; comparisons are with the corresponding 2019 periods.
Financial performance and liquidity
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Revenue | $66.6 million | $83.6 million | $132.1 million | $141.5 million |
| Gross profit / margin | $5.5 million / 8.2% | $9.7 million / 11.5% | $9.4 million / 7.1% | $11.6 million / 8.2% |
| Operating loss | $30.3 million | $34.1 million | $71.2 million | $76.0 million |
| Net loss | $29.3 million | $33.7 million | $68.6 million | $75.0 million |
| Net loss per share | $0.38 | $0.45 | $0.89 | $1.01 |
- Q2 product revenue was $49.6 million, down from $72.4 million; service revenue rose to $17.0 million from $11.2 million. Product gross margin was negative 3.2%; service gross margin was 41.5%.
- For the first half, operating cash used was $48.7 million, versus $54.7 million a year earlier. Investing and financing activities used $1.3 million each. Cash, cash equivalents and restricted cash declined $51.3 million.
- At June 28, cash and cash equivalents were $185.4 million and short-term investments were $20.0 million. Total assets were $390.0 million; current liabilities were $200.1 million. Accumulated deficit was $200.1 million.
- Arlo had no borrowings under its revolving credit facility. The facility permits up to $40 million, subject to a receivables-based borrowing limit, and matures November 5, 2021. The company reported compliance with its covenants.
Material changes and management commentary
- Q2 revenue decreased 20.3% year over year; first-half revenue decreased 6.6%. Management attributed the declines mainly to lower product shipments amid COVID-19 disruption to sales channels, partly offset by higher service revenue and lower sales-return, price-protection and channel-promotion deductions.
- Paid accounts increased 59.4% to 298,000 and cumulative registered accounts increased 33.0% to 4.518 million. Devices shipped fell 44.7% in Q2 to 516,000 and 26.7% for the first half to 1.158 million.
- Gross margin declined, particularly in products, due primarily to higher warranty costs and excess and obsolete inventory provisions. Service costs also rose with cloud-service investment and Verisure development work.
- Operating expenses were lower overall in Q2, while first-half general and administrative expense increased 33.4%, principally reflecting a $7.4 million accelerated stock-compensation charge after the CEO voluntarily forfeited IPO options.
- Cash and cash equivalents plus short-term investments totaled $205.5 million at period-end. Management believed liquidity sources would cover anticipated requirements for at least 12 months, while warning that prolonged market disruption could restrict access to additional capital.
Outlook, risks and unusual items
- No numeric revenue or earnings guidance is provided. Management expected COVID-19 could adversely affect revenue, gross margin and operating expenses for the rest of fiscal 2020. Potential effects include weaker demand, store disruptions, supply delays, reduced productivity and further inventory or receivables adjustments.
- Management expected research and development expense to remain relatively flat in absolute dollars for the rest of 2020, and general and administrative expense to remain relatively flat. It expects interest income to decrease as cash is used and interest rates remain lower.
- Under the Verisure agreements, Verisure is Arlo’s exclusive product distributor in Europe and has a five-year aggregate minimum purchase commitment of $500 million. Verisure prepaid $20 million for 2020 products; the filing describes a further $40 million prepayment for 2021. Arlo also recognized $2.3 million of Verisure development-service revenue in Q2 and $1.0 million of transition-service income.
- Arlo recorded a $1.25 million loss contingency for the federal IPO-related securities class action. A motion for preliminary approval of a class settlement was filed, with a hearing scheduled for September 17, 2020; related state and derivative matters were stayed.
- Other notable exposures include $51.5 million of non-cancellable supplier purchase commitments, with a $2.6 million loss liability; customer and retailer concentration; dependence on third-party manufacturers and AWS; foreign-exchange, tariff and privacy/security risks; and potential impairment of goodwill. A Q1 goodwill test showed fair value $94.1 million, or 53%, above carrying value; management reported no Q2 impairment trigger.
Important facts for investors to verify
- Whether device shipments and product margins recover, and how COVID-19 affects demand, supply availability and inventory reserves.
- Whether paid-account growth translates into recurring service revenue and improved service and consolidated margins.
- Verisure’s fulfillment of minimum purchase commitments and prepayments, and the economics of the European distribution arrangement.
- Cash burn, borrowing availability under the receivables-based credit facility, and the company’s ability to sustain liquidity beyond the stated 12-month horizon.
- Developments in the IPO-related litigation and any resulting settlement costs beyond the accrued $1.25 million.