Arlo Technologies, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 27, 2020; comparisons are to the periods ended September 29, 2019. Amounts below are in U.S. dollars unless stated otherwise.
Business context and reporting period
Arlo sells connected cameras and other smart-home devices and provides cloud and subscription services. It operates as one reportable segment across the Americas, EMEA, and APAC. At quarter-end, it reported approximately 4.8 million cumulative registered accounts and 356,000 cumulative paid accounts. The company’s European commercial operations were sold to Verisure in December 2019; Verisure is now Arlo’s exclusive product distributor in Europe under a five-year supply agreement.
Financial performance and liquidity
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $110.2 million | $106.1 million | $242.3 million | $247.6 million |
| Gross profit / margin | $21.4 million / 19.4% | $10.5 million / 9.9% | $30.9 million / 12.7% | $22.1 million / 8.9% |
| Operating loss | $18.0 million | $31.1 million | $89.2 million | $107.0 million |
| Net loss | $17.5 million | $30.6 million | $86.0 million | $105.6 million |
| Net loss per share, diluted | $0.22 | $0.41 | $1.11 | $1.41 |
- Q3 product revenue was $91.3 million, down from $94.3 million; services revenue was $19.0 million, up from $11.8 million. For the nine months, product revenue declined to $191.6 million from $213.4 million, while service revenue grew to $50.7 million from $34.2 million.
- Cash and cash equivalents were $173.6 million and short-term investments were $20.0 million at September 27, 2020. Current assets were $329.4 million versus current liabilities of $211.8 million. The company reported no borrowings under its revolving credit facility.
- Operating cash flow was negative $59.3 million for the nine months, compared with negative $42.7 million in 2019. Cash, cash equivalents, and restricted cash decreased $63.1 million to $177.8 million. Capital expenditure was $2.1 million.
- Total liabilities were $247.1 million, including $30.4 million of operating lease liabilities. The company reported an accumulated deficit of $217.6 million.
Material changes versus the prior comparable periods
- Q3 revenue rose 3.9%, primarily from higher service revenue and lower sales-return and channel-marketing reductions, partly offset by reduced product shipments. Nine-month revenue fell 2.1% as product shipments were affected by sales-channel disruption.
- Gross margin improved in both comparison periods. Q3 product margin was 13.3% versus 5.9%, and service margin was 48.7% versus 41.9%. For the nine months, product margin improved to 4.8% from 3.0%, while service margin declined to 42.9% from 45.6%, reflecting cloud-service investment and lower-margin Verisure engineering revenue.
- Operating losses narrowed, helped by lower R&D and sales and marketing expenses. Nine-month general and administrative expense rose 22.3%, partly because of $7.4 million of accelerated stock-based compensation after the CEO voluntarily forfeited IPO options. Total stock-based compensation was $26.3 million versus $15.3 million.
- Americas revenue declined 11.3% in Q3 and 9.0% for the nine months. EMEA revenue rose 115.4% in Q3 and 25.4% for the nine months, including the effects of the Verisure relationship. International revenue represented 33.0% of Q3 revenue, compared with 23.3% a year earlier.
- Devices shipped fell 14.1% in Q3 and 21.4% for the nine months. Cumulative paid accounts increased 68.7% year over year.
Outlook, commentary, risks, and unusual items
- Management said existing liquidity, the credit facility, and expected cash generation should meet anticipated cash needs for at least 12 months. It also noted continuing uncertainty from COVID-19 and the possibility that it may need to reduce spending further, draw on the facility, or seek other financing.
- Management expected COVID-19 could continue to reduce revenue and increase product and service costs and operating expenses for the remainder of fiscal 2020. It expected R&D expense to remain relatively flat in absolute dollars for the remainder of the year. No numerical revenue or earnings guidance was provided.
- COVID-19 disrupted retail channels and product shipments; Americas retail-channel inventory was 8.5 weeks, versus 13.5 weeks a year earlier. Freight-in expense increased 41.2% in Q3 and 84.9% for the nine months, reflecting higher airfreight rates. Management warned of possible inventory, receivable, and asset impairment charges, among other effects.
- Verisure has a five-year aggregate minimum purchase commitment of $500 million, subject to the agreement’s terms, and holds exclusive European distribution rights. Arlo recognized $5.5 million of Verisure NRE service revenue and $3.0 million of transition-services income during the nine months. Verisure and other major channels represent significant customer concentration; Q3 revenue included 25.4% from Verisure, 23.6% from Costco, 12.3% from Amazon, and 9.9% from Best Buy.
- The Western Alliance revolving facility is capped at the lesser of $40 million or the borrowing base, generally 60% of eligible receivables less reserves; it matures November 5, 2021. Arlo reported covenant compliance at quarter-end. The facility is secured by substantially all domestic personal property, subject to exclusions.
- A securities class action settlement of $1.25 million received preliminary court approval; Arlo accrued the amount at quarter-end and paid it into escrow in October 2020. Final approval was scheduled for March 11, 2021. The company said it did not believe existing claims were likely to materially affect financial position within 12 months, while noting litigation outcomes remain uncertain.
- Other items include a $292,000 gain from the final Verisure sale working-capital adjustment and a $7.4 million first-quarter stock-compensation charge from the CEO’s option forfeiture. Management reported effective disclosure controls and no material change in internal control over financial reporting during Q3.
Important facts for investors to verify
- Whether subscription growth and service-margin trends can offset declining device shipments and persistent operating cash use.
- How quickly COVID-related channel disruption, higher freight costs, and inventory risks resolve, and whether further impairment or reserve charges arise.
- Verisure’s performance against purchase commitments, payment obligations, and custom-product milestones, as well as the sustainability of the company’s customer concentration.
- Whether available liquidity remains sufficient given operating cash outflows, supplier commitments of $38.1 million, and ongoing losses; confirm the borrowing-base availability and facility covenants.
- The final court approval and distribution of the $1.25 million settlement fund, and any developments in the related derivative and books-and-records matters.
- The effect of ongoing stock-based compensation and equity awards on future expenses and shareholder dilution.