Arlo Technologies, Inc. — FY2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. Arlo sells connected security devices and cloud-based subscription services. The filing is an annual report; it also provides unaudited fourth-quarter results.
Financial performance and liquidity
- Revenue: $370.0 million, down 20.4% from $464.9 million in 2018. Product revenue fell to $323.2 million from $427.1 million; service revenue rose 23.7% to $46.8 million.
- Profitability: Gross profit was $35.8 million versus $92.1 million; gross margin contracted to 9.7% from 19.8%. Operating loss widened to $85.2 million from $74.8 million, and net loss increased to $86.0 million from $75.5 million (loss per share of $1.14 versus $1.12).
- Unusual quarterly result: Fourth-quarter revenue was $122.4 million versus $122.2 million a year earlier. Q4 net income was $19.6 million, compared with a $39.1 million loss, reflecting a $54.9 million pretax gain on the European commercial operations sale. Q4 gross profit was $13.7 million versus $5.0 million.
- Cash flow: Operating activities provided $9.2 million, compared with $17.7 million used in 2018. Investing activities provided $76.3 million, including $52.7 million of sale proceeds. Financing activities used $38,000.
- Liquidity and obligations: Cash, cash equivalents and short-term investments totaled $256.7 million; working capital was $175.7 million. Total liabilities were $339.3 million. Arlo had not drawn on its $40 million revolving credit facility at year-end; availability is subject to a receivables-based borrowing base and covenants. Operating lease liabilities totaled $32.9 million, and non-cancelable supplier purchase commitments were $29.6 million.
- Other indicators: Devices shipped fell 20.2% to 4.06 million, while cumulative paid accounts increased 59.7% to 230,000 and registered accounts rose 40.9% to 4.02 million. Inventory declined to $68.6 million from $124.8 million.
Material changes versus 2018
- Revenue declined across the Americas and EMEA, primarily due to weaker camera demand, competition, and higher marketing incentives and price-protection provisions. APAC revenue increased modestly.
- Lower revenue and weaker product and service margins drove the sharp gross-margin decline. The company cited marketing and price-protection costs, higher warranty, overhead and freight costs, and costs of free subscription trials bundled with new products.
- Research and development, sales and marketing, and general and administrative expenses increased to $69.4 million, $57.0 million, and $47.6 million, respectively. Arlo attributed much of the increase to operating independently after separation from NETGEAR, including its own facilities, IT systems and public-company costs.
- Separation expense decreased to $1.9 million from $27.3 million. Results are not fully comparable with earlier periods: parts of 2018 and 2017 reflect carve-out allocations from NETGEAR, whereas FY2019 reflects standalone operations.
Outlook, risks and contingencies
- Management expected available liquidity and cash generated from operations to fund plans for at least 12 months, while noting that further financing may be needed and is not assured. No specific full-year revenue or earnings guidance is provided.
- Management expected R&D expense to remain relatively flat in absolute dollars and G&A expense to moderately decrease. It expected first-half 2020 revenue and gross margin to be negatively affected by COVID-19-related component-delivery delays and other operational effects.
- The November 2019 Verisure agreements transferred Arlo’s European commercial operations for $52.7 million in cash after working-capital adjustments. Verisure became Arlo’s exclusive European distributor and committed to at least $500 million of purchases over five years beginning in 2020. Arlo also agreed to a three-year restriction on competing with the transferred business.
- Arlo announced a restructuring plan in November 2019 to reduce outside services, headcount, marketing and capital spending; it recorded $631,000 in restructuring charges in 2019.
- Key risks include intense competition and price pressure; reliance on major retail customers and a limited supplier/manufacturer base; cybersecurity, privacy and cloud-service risks; and COVID-19 supply disruption. Best Buy, Costco and Amazon accounted for 32.3%, 10.1% and 9.7% of revenue, respectively; one customer represented 51.3% of year-end accounts receivable.
- Arlo disclosed securities class actions and a related derivative action concerning alleged IPO disclosures. It accrued $1.25 million for the federal action at year-end; the company said the ultimate financial impact was not reasonably estimable. Management reported effective disclosure controls and internal control over financial reporting; the auditor did not provide an internal-control attestation because of Arlo’s emerging-growth-company status.
Important facts for investors to verify
- Whether product demand, shipments and gross margin stabilize after FY2019’s declines, and whether recurring service revenue continues to grow profitably.
- Whether Verisure meets its annual purchase commitments, pays as agreed, and successfully replaces Arlo’s former European sales operation.
- The actual effect and duration of COVID-19-related supply constraints on 2020 sales, margins and product availability.
- Cash burn, receivables concentration, borrowing-base availability and compliance with the revolving facility’s covenants.
- Developments and potential costs in the IPO-related litigation, restructuring and other disclosed contingencies.