Arlo Technologies, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter ended June 30, 2019; comparisons are with the quarter ended July 1, 2018. Six-month figures are for the periods ended on those dates. Dollar amounts below are in millions unless otherwise stated. Arlo sells connected devices and paid subscription services. The prior-year first half reflects carve-out results while Arlo was part of NETGEAR, so expense comparisons are affected by the separation and transition to standalone operations.
Financial results and liquidity
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $83.6 | $110.9 | $141.5 | $211.6 |
| Gross profit / margin | $9.7 / 11.5% | $28.3 / 25.5% | $11.6 / 8.2% | $57.3 / 27.1% |
| Operating loss | $(34.1) | $(16.2) | $(76.0) | $(21.8) |
| Net loss | $(33.7) | $(17.8) | $(75.0) | $(23.2) |
| Diluted loss per share | $(0.45) | $(0.29) | $(1.01) | $(0.37) |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $(54.7) | $(2.7) |
Q2 product revenue was $72.4 million, down from $101.9 million; service revenue was $11.2 million, up from $9.0 million. For the first half, product revenue was $119.1 million versus $194.3 million, while service revenue rose to $22.4 million from $17.3 million. Q2 operating expenses were $43.7 million, including $0.7 million of separation expense; Q2 2018 included $11.3 million of separation expense.
At June 30, 2019, cash and cash equivalents were $93.1 million and short-term investments were $44.9 million, totaling $137.9 million, compared with $201.0 million at December 31, 2018. Current assets were $326.3 million and current liabilities $160.0 million. Total liabilities were $212.2 million and stockholders’ equity $203.2 million. The filing does not disclose conventional borrowings; operating lease liabilities totaled $35.7 million. Six-month investing cash outflow was $1.9 million and financing cash outflow was $1.7 million. Management said available liquidity should meet anticipated needs for at least 12 months, subject to plans and market conditions.
Material changes and management commentary
- Revenue fell 24.7% in Q2 and 33.1% in the first half year over year. Management attributed the decline to weaker connected-camera demand, increased competition, higher price-protection provisions, and marketing spending treated as a revenue reduction.
- Gross margin contracted sharply, primarily due to lower product margins, including higher price protection, channel promotions and, in Q2, increased warranty costs. Lower excess-inventory charges and improved service margins partly offset the decline.
- Paid subscribers increased 83.3% year over year to 187,000, cumulative registered users increased 54.1% to 3.397 million, and devices shipped declined 10.5% in Q2 to 933,000. Management noted that service-revenue growth reflected subscriber gains.
- Operating expenses increased in research and development, sales and marketing, and general and administrative costs as Arlo operated independently and invested in products, cloud services, facilities and corporate functions. The 2018 comparison included NETGEAR-allocated expenses and substantial separation costs.
- Operating cash use increased substantially, primarily due to the larger net loss. Cash and investments declined by $63.1 million from year-end. Inventory fell to $97.2 million from $124.8 million, and accounts receivable to $79.7 million from $166.0 million.
Outlook, risks and unusual items
The filing provides no quantified revenue, earnings or margin guidance. Management expects research and development spending to moderately increase as it develops new products and services; sales and marketing spending is expected to moderately increase over the foreseeable future. Marketing expenditures were expected to remain at a similar level for the rest of 2019, including discounts on earlier-generation products. Management expects interest income to moderately decrease as cash and investments are used to fund operations.
On April 30, 2019, Arlo announced a comprehensive strategic review of alternatives to optimize value and improve stockholder returns, with Deutsche Bank Securities assisting. The filing states that no transaction or specific outcome is assured and that the review may add cost and uncertainty.
Six putative securities class actions and a derivative action allege, among other matters, inadequate disclosure of quality-control problems and adverse sales trends around the IPO. The federal securities case’s amended complaint was met with a motion to dismiss filed August 6, 2019; related state cases were stayed pending that matter. Arlo said the financial impact could not yet be reasonably estimated. Other notable commitments include $32.0 million of non-cancelable supplier purchase commitments, with a $2.8 million loss liability, and lease payment obligations of $45.0 million before $9.2 million of interest.
Goodwill was not impaired in the February 2019 assessment, but the filing warns that further stock-price declines or business deterioration could lead to an impairment charge of up to $15.6 million. Arlo also cites risks from intense competition, concentrated retail channels, product quality and security, third-party manufacturers and cloud infrastructure, foreign exchange, tariffs, and restrictions related to preserving the tax-free NETGEAR separation. Seven securities-related complaints and one derivative action are described; the filing says no material litigation loss is currently estimable.
Investor verification priorities
- Track product demand, price protection, promotional activity and product gross margin to assess whether the steep margin decline stabilizes.
- Verify whether subscriber and service-revenue growth continues and increasingly offsets falling device shipments.
- Monitor operating cash burn, liquidity, inventory turns and supplier commitments against management’s 12-month liquidity assessment.
- Follow the strategic review for any announced transaction, costs or implications for financing and business plans.
- Check developments in the IPO-related litigation, goodwill impairment indicators, product-quality claims and customer-channel concentration.