Arlo Technologies, Inc. — Q1 2020 Form 10-Q
Reporting period: Fiscal quarter ended March 29, 2020, compared with the three months ended March 31, 2019. Arlo sells connected devices and subscription services. The company delayed this filing while completing an impairment assessment amid COVID-19-related stock-price volatility.
Financial performance
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Revenue | $65.5 million | $57.9 million |
| Gross profit / margin | $4.0 million / 6.0% | $1.9 million / 3.4% |
| Operating loss | $40.9 million | $41.9 million |
| Net loss | $39.3 million | $41.3 million |
| Diluted loss per share | $0.51 | $0.55 |
| Cash used in operating activities | $48.9 million | $15.5 million |
- Product revenue was $50.7 million and services revenue was $14.7 million. Total revenue grew 13.1% year over year; services revenue increased 30.7%, while device shipments declined 0.8% to 642,000.
- Cash, cash equivalents and short-term investments totaled $206.6 million at quarter-end, down from $256.7 million at December 31, 2019. Cash, cash equivalents and restricted cash decreased $60.3 million during the quarter.
- Current assets were $341.6 million and current liabilities were $190.5 million. Total liabilities were $231.6 million; the filing reports no drawn borrowings. A revolving credit facility provides up to $40 million, subject to a receivables-based borrowing limit; Arlo was compliant with covenants.
- Stockholders’ equity was $178.6 million and accumulated deficit was $170.8 million. Stock-based compensation expense was $12.8 million, versus $4.7 million a year earlier.
Changes versus the prior comparable period
- Revenue and gross margin improved, but Arlo remained significantly loss-making. Gross profit rose by about $2.0 million as lower channel promotion deductions improved product margin; increased warranty costs and scrap provisions partly offset the improvement. Service margin declined amid investment in cloud services.
- Operating cash use increased by $33.4 million, primarily reflecting supplier payments for fourth-quarter 2019 purchases and the timing of working-capital movements. Accounts payable fell to $39.1 million from $111.7 million at year-end.
- Research and development expense fell 16.1% and sales and marketing expense fell 22.4%, reflecting prior workforce reductions, the transfer of European commercial operations to Verisure, and reduced travel. General and administrative expense rose 78.3%, mainly because the CEO’s voluntary forfeiture of IPO options accelerated recognition of $7.4 million in compensation cost.
- International revenue was 30.4% of total, versus 27.8% a year earlier. APAC revenue rose 83.3%; EMEA revenue fell 18.6%.
Outlook, risks and unusual items
- Outlook: Arlo provided no numerical revenue or earnings guidance. Management said COVID-19 had not materially adversely affected Q1 results but could reduce revenue and gross margin and increase costs and operating expenses for the remainder of fiscal 2020. The company cited store closures or lower foot traffic, supply delays, deferred customer spending and reduced productivity. Management believed available liquidity and the credit facility would cover anticipated needs for at least 12 months, while noting the pandemic could affect access to future capital.
- COVID-19 and impairment: The company performed a quantitative goodwill impairment test after the pandemic-related share-price decline. Estimated fair value exceeded carrying value by $94.1 million, or 52.7%; no goodwill impairment was recorded. A further decline in share price or business deterioration could lead to an impairment charge of up to $11.0 million. No intangible-asset impairment was recorded in the quarter.
- Verisure: Verisure has exclusive distribution rights for Arlo products in Europe and a five-year aggregate minimum purchase commitment of $500 million under the supply agreement. Arlo recognized a $0.3 million final working-capital adjustment gain and $0.9 million of NRE service revenue in Q1. Management’s expectation that European revenue and profitability improve over the agreement’s term is not assured.
- Other unusual items: Arlo recorded $1.1 million of Verisure transition-services reimbursements in other income, substantially contributing to the year-over-year increase in other income. The company also reported a $1.25 million accrual for the Federal Action securities litigation. A proposed class-wide settlement process was underway; related state and derivative cases were stayed.
- Concentration and execution risks: Q1 revenue included 20.7% from Costco, 19.2% from Best Buy, 13.1% from Amazon and 11.0% from Verisure Ireland and affiliates. The filing highlights channel dependence, third-party manufacturing and component supply, competition, product quality, cybersecurity, and reliance on Amazon Web Services.
Key facts for investors to verify
- Whether COVID-19 materially changes demand, distributor activity, supply availability, returns, inventory reserves or liquidity after March 29, 2020.
- Whether subscription growth translates into improved service margins and recurring revenue; paid accounts for the period increased 57.4% to 255,000.
- Whether Verisure meets its purchase commitments and whether the partnership supports the expected European performance.
- Whether cash burn and working-capital needs remain consistent with management’s stated 12-month liquidity assessment, and whether credit-facility borrowing availability is sufficient under its borrowing-base and covenant terms.
- Whether the goodwill valuation cushion remains adequate and how the securities litigation and settlement process develop.