Arlo Technologies, Inc. (NYSE:ARLO) Q1 2024 Earnings Call Transcript May 9, 2024
Arlo Technologies, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Ladies and gentlemen, thank you for standing by. At this time, all participants are on a listen only mode. Later we will conduct a question-and-answer session. [Operator Instructions]. I would now like to turn the conference over to Tahmin Clarke. Please go ahead, sir.
Tahmin Clarke: Thank you, operator. Good afternoon, and welcome to Arlo Technologies’ First Quarter 2024 Financial Results Conference Call. Joining us from the company are Mr. Matthew McRae, CEO and Mr. Kurt Binder, CFO. The format of the call will start with an introduction and commentary on the business provided by Matt, followed by a review of the financials for the first quarter along with guidance for the second quarter, provided by Kurt. We will then take questions. If you have not received a copy of today’s release, please visit Arlo’s Investor Relations website at investor.arlo.com. Before we begin the formal remarks, we advise you that today’s conference call contains forward-looking statements. Forward-looking statements include statements regarding our potential future business, operating results and financial condition, including descriptions of our revenue, gross margin, operating margins, earnings per share, expenses, cash outlook, free cash flow and free cash flow margin, guidance for the second quarter of 2024, the long-range plan targets, the rate and timing of paid subscriber growth, the transition to our services-first business model, the commercial launch and momentum of new products and services strategic objectives and initiatives, market expansion and future growth partnerships with various market leaders and strategic collaborators, continued new product and service differentiation and the impact of general macroeconomic conditions on our business, operating results and financial condition.
Actual results or trends could differ materially from those contemplated by these forward-looking statements. For more information, please refer to the risk factors discussed in Arlo’s periodic filings with the SEC, including the most recent annual report on Form 10-K and quarterly report on Form 10-Q. Any forward-looking statements that we make on this call are based on assumptions as of today, and Arlo undertakes no obligation to update these statements as a result of new information or future events. In addition, several non-GAAP financial measures will be discussed on this call. A reconciliation of the GAAP to non-GAAP measures can be found in today’s press release on our Investor Relations website. At this time, I would now like to turn the call over to Matt.
Matthew McRae: Thank you, Tahmin, and thank you everyone for joining us today on Arlo’s first quarter 2024 earnings call. Before we jump into the details of our Q1 results, I would like to take a moment to review our long-range plan and strategy. You will recall from our last earnings report, Arlo set forth new and more ambitious long-range targets based on the stellar execution by the team across the business. At or before 2030, our goal is to achieve 10 million paid accounts, $700 million in annual recurring revenue and over 25% non-GAAP operating margin. Our strategy to accomplish these goals focuses on several areas. First is our retail and direct business, where we sell devices and service subscriptions to consumers. Last year, we rebalanced our pricing strategy by reducing hardware margins and increasing our service fees, which lowered the barrier of entry in a slower consumer market, driving share gains and faster household formation for Arlo.
In the 2023 holiday period, our essential two product line performed well, especially at big box retailers, providing a clear indication that the DIY home security segment is entering the mass market. Along with helping us navigate a slower consumer climate in the near-term, this shift in pricing opened a broader addressable market for Arlo and is a key dimension in our plans to continue our strong paid subscription growth leading to expansion of both our service revenue and profitability. Looking ahead, we believe the macroeconomic environment will remain muted in 2024. Thus, we plan to leverage the same strategy we executed last year, as we planned for the important back half of the year. While lower ASPs may bring down hardware revenue, we expect to benefit again from incremental growth in households and service revenue going into 2025.
I’m excited to report that the strategy has already begun to bear fruit, as we have similar to last year a confirmed robust promotional calendar with some of the largest retailers in the world for this coming holiday season. Second is strategic accounts or our B2B relationships. Kurt and I mentioned on our previous call that we believe more than half of the growth in our long-range targets could come from our partnerships. Arlo is experiencing a resurgence in interest and engagement across several verticals and we are more confident than ever that these strategic accounts will play an important role in our future success. Reinforcing that notion, today, we announced the renewal of our agreement with Verisure, one of our oldest and most important strategic partners.
Arlo will continue to provide devices, custom development, AI-powered services and our cloud platform technologies to Verisure for another five years, as they continue to grow their business across Europe and Latin America. I want to congratulate Verisure on their success and we look forward to working together as we support their next wave of growth. The last area of focus is our capital allocation plan, which is being built to maximize shareholder value through careful and disciplined deployment of our resources. Our internal investment in Arlo’s innovation pipeline continues to enhance our market position from the successful Essential 2 portfolio rollout to the anticipated launch of our Arlo Secure platform later this year with its groundbreaking AI-powered capabilities.
While the smart security category is maturing, I see a new wave of innovation over the next 24 months to 36 months, and Arlo could not be better positioned to strengthen our leadership in the space. As evidence of our current leadership position, this quarter Arlo won an American Business Award for Innovation of the Year. Adding to our previous accolades including the Smart Security Camera Company of the Year award from IoT Breakthroughs and our recognition for innovation and excellence from Newsweek. Other aspects of our capital allocation plan are underdeveloped and we plan on providing additional insight and detail over the coming months. With that overview as context, you can see why we are so pleased with our operating results in the first quarter.
Arlo ended with 3.2 million paid accounts in Q1, growing our base by 58% year-over-year. Our annual recurring revenue grew over 24% year-over-year to reach $227 million, driven by retail and direct subscriptions from our successful holiday sales, and total revenue was $124 million up 12% year-over-year and driven by the anticipated recovery of Verisure orders after their destocking event at the end of 2023. This outstanding performance resulted in a non-GAAP earnings per share of $0.09 and the business generated an incredible $19.5 million of free cash flow at a free cash flow margin of 15.7%, a record for the company and a result that truly demonstrates the success of our Services First business model. I would like to give my congratulations and extend my appreciation to the entire Arlo team.
Our Q1 results represent a great first step towards successfully achieving our new long-range targets. And now, I’ll turn it over to Kurt for a more in-depth review of these Q1 results.
Kurt Binder: Thank you, Matt, and thank you, everyone, for joining us today. I will start by sharing some financial details and an overview of the business for Q1 of 2024. Total revenue for the first quarter of 2024 came in at $124.2 million, up 12% over the prior year period. In the quarter, service revenue represented about 46% of total revenue, up from 40% in the same period last year. This shift in revenue composition reflects the continued momentum that we have gained in our transformation to a services first business. Our installed base of subscribers continued its strong growth trajectory, as we reached over 3.2 million paid accounts by the end of Q1, an increase of approximately 422,000 paid accounts in the quarter. This number does include a significant catch up of Verisure accounts that we have discussed on previous calls.
We expect the catch up to continue for one or two more quarters. Service revenue for Q1 was another record at $56.7 million or a 29% increase over last year. The strong service revenue performance was driven by our increase in pricing across our paid accounts last year as well as the growth in our overall paid account base. Our annual recurring revenue at March 31st was $227 million up 24% over the same period last year. I want to highlight the strength of our services revenue and ARR, which helped to deliver solid revenue performance and contributed to Arlo generating non-GAAP operating profit of $8.6 million in the quarter. This represents 6 times increase in operating profit over the same period last year. Product revenue for Q1 was $67 million, which was down sequentially from our seasonally strong holiday quarter, but inline with the revenue generated in the same period last year.
During the quarter, we shipped a total of 1.1 million devices worldwide compared to 960,000 in the prior year period. Product revenue at these levels was driven by the higher unit volume offset by the continuing decline in ASPs in most product categories. Our lower cost Essential 2 camera lineup has positioned us to gain a greater share of households as we enter into the mass market phase of home security. We believe that customers of these products that come to Arlo through channels like Walmart represent an incremental subscriber opportunity for our services business. And given the strong commitment to the smart securities segment by some of our largest retail partners, we will use product pricing as a lever to go after additional market share even if it results in product gross margins being below the mid-single-digit range to drive additional service revenue growth in 2025.
In the quarter, approximately $70 million or 56% of our total revenue was generated from our international customers. Specifically, our sequential results for the EMEA region improved significantly as we experienced a material uptick in orders from our largest partner, which resulted in them surpassing the $500 million minimum purchase commitment threshold on our contract during the period. As Matt mentioned, we remain extremely pleased with our Verisure relationship, and we are excited to share the recent news that the existing contract was renewed through 2029. From this point on, my discussion will focus on non-GAAP numbers. The reconciliation from GAAP to non-GAAP figures is detailed in our earnings release distributed earlier today. Our non-GAAP gross profit for the first quarter was $49 million up 35% year-over-year.
This resulted in a non-GAAP gross margin of 39%, up over 600 basis points from 33% in Q1 of 2023. The year-over-year increase in non-GAAP gross profit was primarily attributable to the continued expansion of our services business and associated gross margin. Non-GAAP service gross margin for the quarter was 76.7%, up from approximately 73.5% in the same period last year. The improvement in non-GAAP service gross profit was driven by growth in our total paid subscriptions and the pricing increase implemented in February of last year. Non-GAAP product gross margin for the quarter was 8% consistent with the previous quarter, but up 200 basis points from the same period last year. Product margin of 8% is slightly high, but still in line with the mid-single digit guidance that we provided when we gave our full year 2024 outlook.
Total non-GAAP operating expenses for the first quarter were $40 million, up both on a sequential and year-over-year basis and inline with the expectations we shared last quarter. The year-over-year increase is partially attributable to the increase in R&D expenses as we are investing in the development of Arlo Secure 5.0. We are keeping our operating expenses in check while delivering higher levels of service revenue as a percentage of total revenue. We will continue to exercise a disciplined approach to our cost structure, as we scale the services business. In Q1, we posted non-GAAP net income of $9.5 million. Our non-GAAP net income translates into income per diluted share of $0.09. Regarding our balance sheet and liquidity position, we ended the quarter with $142.9 million in available cash, cash equivalents and short-term investments.
This balance was up more than $24 million year-over-year and underscores the strength of Arlo’s capital position right now. We generated a record $19.5 million in free cash flow in Q1, which represents free cash flow margin of 16%, an improvement driven by both our increased profitability and solid working capital management. For instance, our Q1 accounts receivable balance was $56.5 million at quarter end with Q1 DSOs at 41 days, down from 44 days in the same period last year. Our continuing improvement in DSOs reflects our focus on improving our working capital position. We are pleased with our strong liquidity position, which provides us with options to leverage our cash for strategic initiatives to help accelerate our growth in the smart security market.
Finally, our Q1 inventory balance ended at $44.7 million, up $6.3 million from Q4 2023 levels. Inventory turns were 5.7 times down from 7.6 times in Q4, but inline with our expectations as we look to optimize our inventory levels in an effort to reduce spend on inbound freight, especially airfreight. Now turning to our outlook. We expect the second quarter revenue for 2024 to be in the range of $120 million to $130 million and our non-GAAP net income per diluted share to be between $0.06 and $0.12 per share. We are positioned well with the new low cost Essential 2 camera portfolio in this more cautious consumer market. Consumers are continuing to make purchase decisions based on promotional activity and our ability to deliver a great product in an entry-level price point allows us to expand our strong market position as the Security segment enters the mass market phase of adoption.
Service revenue is still forecasted to grow at approximately 20% over last year, thereby becoming a much larger portion of our overall revenue and profitability mix. We continue to expect non-GAAP service gross margin to be in the 75% range for 2024. Now, I’ll open it up for questions.
Operator: [Operator Instructions]. Our first question comes from the line of Mark Kash [ph] with Raymond James. Your line is now open.
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