Arlo Technologies, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; compared with the three months ended April 1, 2018. Arlo sells connected devices and paid subscription services and operates as one reportable segment. Following its 2018 IPO and December distribution of shares by NETGEAR, Arlo reported as a standalone company. Unless otherwise indicated, amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | Q1 2019 | Prior comparable period |
|---|---|---|
| Revenue | $57.9 million | $100.6 million |
| Gross profit / margin | $1.9 million / 3.4% | $29.1 million / 28.9% |
| Operating loss | $41.9 million | $5.6 million |
| Net loss | $41.3 million | $5.4 million |
| Basic and diluted loss per share | $0.55 | $0.09 |
| Operating cash flow | $(15.5) million | $25.4 million provided |
- Product revenue was $46.6 million, down from $92.4 million; service revenue was $11.3 million, up 37.3% from $8.2 million.
- Product costs were $50.3 million, exceeding product revenue. Total cost of revenue fell 21.9%, substantially less than the 42.5% revenue decline.
- Operating expenses rose to $43.8 million from $34.7 million. R&D was $18.2 million, sales and marketing $14.2 million, general and administrative $10.5 million, and separation expense $0.9 million.
- Cash, cash equivalents and short-term investments totaled $180.4 million at March 31, 2019; cash and cash equivalents alone were $135.6 million. Cash, cash equivalents and restricted cash declined by $15.7 million during the quarter.
- Current assets were $394.4 million and current liabilities $201.2 million. Total liabilities were $248.2 million. The filing reports no conventional borrowings in the presented balance sheet; operating lease liabilities were $28.4 million in total, including current lease obligations within accrued liabilities.
- Inventory increased to $131.2 million from $124.8 million, while inventory turns fell to 1.5 from 3.6 in Q4 2018. Non-cancelable supplier purchase commitments were $28.1 million, with a $2.9 million loss liability for committed purchases.
Material changes and operating indicators
- Revenue fell 42.5%, which management attributed primarily to weaker demand for connected cameras, increased competition, and higher marketing expenditures treated as reductions of revenue. Revenue declined across the Americas, EMEA, and APAC.
- Gross margin dropped to 3.4% from 28.9%, primarily because of higher such marketing deductions; service margin also weakened amid continued investment in cloud services and security.
- Cumulative registered users increased 62.1% to 3.126 million and paid subscribers increased 89.1% to 174,000. Devices shipped declined 28.5% to 647,000.
- Cash from operations turned negative. Collections of accounts receivable and NETGEAR receivables benefited working capital, but payments of accrued liabilities and the larger net loss weighed on operating cash flow.
- Accounts receivable fell to $71.6 million from $166.0 million, and receivables from NETGEAR fell to $0.1 million from $12.2 million. DSO decreased to 111 days from 125 days at year-end.
- Q1 2018 results included $13.8 million of allocated NETGEAR corporate costs, while Q1 2019 reflected standalone operations. The periods are therefore not fully comparable; standalone operating costs are expected to be higher than historical carve-out periods.
Outlook, risks and unusual items
- No numerical full-year revenue or earnings guidance is provided. Management expected moderate increases in R&D and sales and marketing spending; it also anticipated further marketing discounts on older-generation products to stimulate sales.
- Management said available liquidity should cover anticipated requirements for at least the next 12 months, while noting that additional financing might be sought and is not assured. Tax-agreement restrictions following the NETGEAR distribution may limit certain transactions, including equity issuances, for two years.
- On April 30, 2019, after quarter-end, Arlo announced a comprehensive strategic review of alternatives and retained Deutsche Bank Securities. The filing gives no assurance that the review will produce a transaction or other specific outcome.
- A sharp stock-price decline prompted a goodwill impairment test. Goodwill was not impaired as of March 31, 2019, but further deterioration could result in an impairment charge of up to $15.6 million.
- Putative securities class actions allege that Arlo inadequately disclosed product-quality issues and adverse sales trends ahead of its IPO. The company said the potential financial impact was not reasonably estimable; the claims seek unspecified damages.
- Other material exposures include reliance on a small number of retail channels, competition and pricing pressure, product-quality and cybersecurity risks, dependence on third-party manufacturers and AWS, foreign-exchange and tariff exposure, and the possibility of excess or obsolete inventory.
- Arlo adopted the new lease accounting standard in Q1, recognizing operating lease right-of-use assets and liabilities. It also derecognized the prior build-to-suit headquarters asset and financing obligation; these accounting changes affected balance-sheet presentation.
Key facts for investors to verify
- Whether the severe product-revenue and gross-margin declines stabilize, and whether discounts on older products further affect margins.
- Whether subscriber growth translates into durable recurring revenue and improved service economics.
- Inventory levels, turns, purchase commitments, returns and the adequacy of the committed-purchase loss liability.
- Cash burn, liquidity needs and the company’s ability to fund operations without additional financing.
- Developments in the strategic review, IPO-related litigation and goodwill impairment indicators.
- Customer concentration: the filing reports 31.0% of Q1 revenue from Best Buy, 10.9% from Costco and 8.0% from Amazon and affiliates.