Arlo Technologies, Inc. (ARLO) Earnings Call Transcript & Summary

Thank you. Ladies and gentlemen, thank you for standing by. At this time, all participants are in listen-only mode. Later, we will conduct a question and answer session. At that time, if you have a question, you will need to press the star 1 on your push button phone. I would now like to turn the conference over to Tommen Clark.

Please go ahead. Before we begin the formal remarks, we advise you that today's conference call contains forward-looking statements. Other looking statements include statements regarding our potential future business, operating results and financial condition, including our description of revenue, gross margins, operating margins, earnings per share, expenses, cash outlook, free cash flow and free cash flow margin, ARR, and cash flow. KPIs, the guidance for the third quarter and full year 2026, the long-range plan targets, the rate and timing paid subscriber growth, the commercial launch and momentum of new products and services, timing and impact of tariffs, 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 our quarterly report on Form 10-Q filed earlier today. 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. Reconciliation of the gap to non-gap 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.

Thank you, Tom. And thank you, everyone, for joining us today on ARLO's second quarter 2026 earnings call. Marlo delivered outstanding results in Q2 with service revenue, total revenue, gross profit, and non-GAAP net income all setting new records for the company. We saw strength across the business and across all channels, which in addition to the team's great execution, generated the excellent outcome you see today. of sale units in our retail and direct channel were up 8%, which contributed to the nearly 300,000 paid account additions in the quarter. This brings our total paid accounts to 6.3 million, which is substantially ahead of the original trajectory to our long range target of 10 million. the quality of our paid account portfolio continues to increase when compared to the same period last year. Our average revenue per user is up, churn is down, and both monthly and annual subscription renewals came in higher than our forecast. These continuous improvements are due to several internal projects and programs that utilize deep user insights, which are focused on delivering the best user experience in the world. The result is Arlo's lifetime value of a paid account has risen to $967, which is about 15% compared to a year ago. Total revenue grew to $156 million, up more than 20% year over year and setting a new record for the company. Service revenue of $93 million, also a new record, grew 19% year over year and comprised 60% of our total revenue in the quarter. This top line performance drove an incredible 70% year over year growth in adjusted EBITDA, which reached $31 million in Q2. And when combined with a partial tariff refund, propelled non-GAAP earnings to $0.28 per share, up 65% when compared to a year ago. As in past years, we use this mid-year checkpoint to assess the marking conditions and our performance over the first half as we finalize plans for the second half and begin the development of our annual operating plan for 2027. Our focus is to utilize Arlo's resources to deliver growth in both the short-term and long-term to drive the expansion of shareholder value. The capital allocation strategy that we rolled out nearly two years ago has served as an excellent framework to drive that growth in value. Our investments across the pillars of organic, inorganic, and shareholder return are delivering the desired outcomes, and I would like to spend a moment to update our investors. Our organic or internal investments fall into three main buckets, operational excellence, sales and marketing, and platform innovation. Operationally, Arlo is deploying new tools and processes that, when coupled with our vast user data, are unlocking value and providing detailed insights that we are leveraging to improve the key metrics I mentioned earlier. We are still at an early phase and will continue to invest where we see the potential for high ROI or improvement in Arlo's key metrics. From a sales and marketing perspective, you will see us balance both short term and long term growth. As in past years, we intend to invest in our retail channels during the holiday selling period to drive incremental growth in subscribers now worth nearly $1,000 each in LTV. And you'll see us also invest in some market tests for both care and small business segments to collect data that will help feed our 2027 business plan and other future opportunities for growth. It is exciting to see Arlo on the cusp of entering these large markets that can generate substantially higher ARPU and LTV. Finally, our internal innovation pipeline has never been stronger. Arlo will launch Secure 7 at the end of Q3 with several new features and capabilities that keep us at the forefront of smart security and open the door to additional service plan options at higher price points. And looking into 2027, Arlo will be launching a next generation product line, coupled with Arlo Secure 8, that together will represent the most innovative and impactful advancement to customer experience in home security since Arlo's initial launch of DIY security more than 10 years ago. Looking at the inorganic area of our capital allocation plan, Arlo generated a greater than 50% return from our origin AI investment. And the acquisition of Allocare has enabled Arlo to address the 30 plus billion dollar market for smart elder care and aging in place. Based on the early progress since the acquisition closed, we expect to have several additional partner announcements that will contribute to growth in 2027. We remain bullish but selective on future inorganic investment opportunities and continue to look for either smaller adjacent assets or potentially larger options if they fit directly into our core market. From a return to shareholder perspective, Arlo has bought back nearly 6 million shares since the inception of our shared repurchase program and more than $20 million of shares in Q2 alone. The board and the management team continue to believe that Arlo's shares are substantially undervalued and you should expect to see additional share repurchases going forward. Taking this all together, Arlo had a record-breaking Q2, strong first half, and is executing a capital allocation plan that is contributing to short-term growth while positioning the company for additional growth in 2027 and beyond. I have never been more excited about Arlo's potential and believe that the next 18 to 24 months will begin a new phase of success for the company. And now I'll turn it over to Kurt for a more detailed review of our Q2 results and our outlook for the remainder of 2026.

Thank you, Matt. And thank you everyone for joining us today. First, I will provide a detailed review of the key operational and financial results of the business. Then I will share an overview of our expectations for the third quarter, followed by an updated outlook for full year. We continue to deliver outstanding top and bottom line growth driven by a quarter of record subscriptions and services revenue, coupled with record total revenue. Arlo continues to outperform expectations as a result of our subscriptions and services focus, which drives our expanding profitability metrics, including record levels of non-GAAP gross margins, adjusted EBITDA, and non-GAAP net income. And we are well positioned to continue these trends into the back half of 2026. During the period, we posted subscriptions and services revenue of $93 million, up 19% year-over-year, and once again accounting for 60% of total revenues. Our subscriber base grew 23% year-over-year, as we generated 298,000 new paid accounts in the period. This double-digit subscriber growth was bolstered by our outstanding customer retention efforts, especially the results generated in our retail business. Our subscriber growth, coupled with a slight increase in ARPU, drove ARR to $365 million, up 16% year-over-year. Product revenue was $62.9 million, up 23% from $51.2 million in the same period last year. a trend driven by strong growth in international business, as well as strong device shipments into retail channels advance of Amazon's Prime Day, which began in late Q2 of this year. Both of these factors resulted in additional retail sales with POS or point of sale volume increasing 9% for the first half of 2026 in comparison to the same period last year. Our strategy to optimize our promotional campaigns around retail channels and product offerings that have higher subscription conversion rates helped enhance growth of our high-margin domestic retail subscription offerings. Total revenue for the period came in at $155.9 million, a record and up 21% from the prior year. driven by the strong double-digit year-over-year growth in both subscriptions and services revenue, as well as higher product revenue. Generating total revenue at this level is a testament not only to the strength of our services revenue trajectory, but also to the diversification of our go-to-market strategy. 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, which was distributed earlier today. In line with our guidance, non-GAAP subscriptions and services gross margin was 84.1%. which was slightly impacted by non-recurring engineering services revenue or NRE associated with the ramp of our strategic partners. We reported non-GAAP product gross margins of 1%, up significantly from the negative 13.8% in the prior year period, primarily related to the $8 million in tariff refunds were recorded during the period, as well as a higher mix of product sales coming from our strategic partners. On a pro forma basis, after adjusting for tariff refunds in the quarter, our product gross margins would have been a negative 11.6%, which still represents an improvement of 220 basis points year over year. With the improvement in both services and product gross margins, we again surpassed the 50% consolidated non-GAAP gross margin level, an increase of 480 basis points year-over-year. Consolidated gross margins at this level represents a new record and underscores the continuing uplift in profitability we are experiencing. Total non-GAAP operating expenses for the second quarter were $48.6 million, up 16.5% from $41.7 million in the same period last year. The year-over-year increase is driven by investments in R&D, including headcounts that continue to drive our technology innovation ahead of our Arlo Secure 7 launch. Additionally, as mentioned earlier in the year, we are investing in delivering platform advancements for our strategic partners ahead of their launch of services. Lastly, we experienced an increase in fees associated with professional services to support our growth initiatives and deliver an enhanced customer experience. During the quarter, adjusted EBITDA was $30.6 million, up 70% year-over-year and representing an adjusted EBITDA margin of 20%. Even in an investment year, which requires additional spend to integrate large-scale strategic partners into our platform, We are still expanding our adjusted EBITDA and margins, a testament to the significant operational and financial progress Arlo has made in its transformation. Profitability at this level translates into non-GAAP net income per dilutive share of $0.28, including a favorable $0.07 impact due to tariff refunds. On a pro forma basis, assuming the exclusion of tariff refunds, our non-GAAP net income per dilutive share would have been 21 cents ahead of both the midpoint of our guidance range and consensus EPS estimates in the quarter. Regarding our balance sheet and liquidity position, we ended the quarter with $141 million in available cash, cash equivalents, and short-term investments. This balance includes investments in various capital allocation initiatives, including $22 million as part of our stock repurchase program and $15 million as the cash paid in the period to acquire Allocare. For the six months ended June 28, 2026, we generated $33.9 million in free cash flow, or a free cash flow margin of 11%. Our Q2 accounts receivable balance was $63.6 million at quarter end, with DSOs at 37 days, down from 43 days last year as we continued to drive more subscribers to annual service offerings. Our Q2 inventory balance was $48.4 million, up from the $30.9 million level last year. Inventory turns, excluding acquired inventory, were 5.5 times, a decline from 7.7 times last year, as we look to optimize our inventory levels in an effort to reduce our shipping costs and manage any potential future increase in memory costs. Now, turning to our outlook, we had an outstanding start to the year, driven by ongoing strength in our subscriptions and services business, which drove both our revenue and profitability. Looking forward, we expect the momentum in our subscriptions and services business to continue into the second half of 2026. And we expect total revenue in the third quarter to be in the range of $140 to $150 million. From a profitability perspective, we will leverage any Q3 tariff refund to further invest in the strategic areas that are fueling our growth. This includes strategic partners such as Comcast and ADT, second half promotional campaigns with our top channel partners. innovation across our technology platform, and market tests ahead of our 2027 annual operating plan. Despite these incremental investments, we expect our non-GAAP net income per dilutive share in the third quarter to be substantially ahead of consensus and in the range of 17 cents to 23 cents. As a result of our strong first half and our outlook for the remainder of 2026, we are significantly increasing our outlook for total revenue in EPS for the full year. We are now expecting total revenue for the year to be in the range of $580 to $600 million, and non-GAAP net income per dilutive share to be in the range of $0.90 to $1.

Now I'll open it up for questions. At this time, I would like to remind you all that to ask a question, please press star one on your telephone keypad. To withdraw your question, press star one again. for just a moment to compile the Q&A roster. Your first question comes from the line of Jacob Steffen from Lake Street Capital Markets. Please go ahead.

Hey guys, appreciate you taking the questions. Congrats on a really nice quarter here. maybe just first kind of looking at, you know, the full year guide raise. I guess when you kind of think about ARR growth for the full year, I mean, where does that land and how comfortable are you.

with those targets. Yes, thanks for the question, Jacob. As you saw, we had some really strong growth on the service revenue side, just touching about almost 20%. And what I would say is if you look at the metrics we talked about on the call, so churn improving, conversion improving, ARPU actually raising up a little bit, that is driving that LTV almost to a thousand dollars. And that's usually a leading indicator or further growth when you're looking when you look out on ARR as you go through the year. I would couple that with Arlo Secure 7 launch. That's going to be happening sometime in September. And that is not only going to bring a lot of new functionality to the table, it's enabling us to bring a higher tier of service. So you're going to see us actually add a subscription tier that's higher priced than the two that we have in the field today. And that obviously served to grow ARR as we exit the year. So typically you see some strengths and some growth in ARR as we get towards the end of the year because of our launch of our products. But I think the metric improvement is usually a leading indicator as well. So we are targeting towards that 20%, not only on service revenue, which we're basically at now,.

but also on ARR as we exit the year. OK, got it and you know, maybe just on secure 7 since you talked about it, you highlighted the Q3 launch. I guess, you know, what features are going to be incremental about Secure 7 that aren't already in Secure 6? And how do you think about kind of the market appetite for higher ARPU offerings at this point?.

Yes, so I don't want to get ahead of our launch in too much, but there are some functionality and some features that I think we've talked about in the past already. So I can touch on those and give you a little bit more color on why we're excited about it. So first we've talked about, and I think most importantly, we've talked about the idea of the next level of AI enhancement or AI capabilities in the consumer security space. And so if you look at what most AI is doing, it's usually object detection, or it's inferring from facial recognition or certain things you're detecting an object and notifying or taking action based on that. What we have been working on for more than a year now is actually going to that next level and actually assessing the entire event and what is the threat level given for that. And so that inferment or that assessment of what's actually happening is a whole nother level of of what AI can do and provides numerous improvements to both user experience and the speed of emergency response in those events that really require that while also filtering out a false alarm. So it's a functionality that I think is going to be a dramatic improvement to the customer experience, number one, but it's also something think that we can be leveraged with our strategic partners to have a much better outcome, both on the speed of the response, but also reducing false detection. So I would say that is probably the most groundbreaking. and really the next wave of innovation that we think is going to come over the next three to five years in the, call it advanced AI security space. You're also going to see numerous customer enhancements that have been asked for or requested over the last year and a half. And that's something we typically do is we roll up all of the functionality and feature requests that we've seen the past year and roll those into user improvements, the app level or the service level. There are also some, we have a class of users that actually pay separately for something we call CVR, continuous video recording, and you're going to see a new tier of service, but also a lot of, HANSA that we think is going to unlock the benefits of a higher tier service as well. So there's a lot in there. That gives you a little bit of the bucket, but we'll obviously talk a lot more about it and have a lot more detail when it launches in September.

Okay, got it. And maybe just last one for me. I mean, the last few quarters, we talked a lot about strategic partnerships. very notable ones ADT, Samsung and Comcast. I'm wondering if you could kind of give an update on some of those and obviously ADT Blue is launched, but how are things with Comcast Xfinity? Where are you in the testing phase with that? Any updates would be helpful. Thanks. Yes.

Thanks for the question. And it's, I didn't actually touch on that in the prepared remarks. And so I think it's a great thing to touch on. Everything is progressing extremely well. So, ADT has now launched. And as we said before launch, we expect them to kind of ramp through this time year, especially in the back half if you come into a holiday quarter and then lean in even more for a full year next year. And that's exactly what we're seeing. I can't share anything, but we're expecting some significant marketing spend and some from ADT for that blue offering they have in the market. So expect to see that to grow and then expand as we get into the first part of next year and have a full year of launch there. So we're excited to see that and that's on track. Same thing with Comcast. So Comcast on a different timeline, but the integration and development with them is exactly on track. We spent some time with them actually in Philadelphia over the last couple of weeks. And I would say, if anything, there's actually probably more opportunity with this partnership across even more fronts of some of the services they want to deploy, deploy over time. So we're heads down. Everything's on track. And I would say, if anything, there's a desire to maybe, you know, try and get this launched closer to you on the Q2. but a lot of it will depend once we get test units into the field. And I'll save any more detail when we get closer to launch and Comcast. I'll have a lot more to say about that probably in the first half of next year. Very helpful guys, nice quarter. Thank you very much.

Your next question comes from the line of Dylan Becker from William Blair. Please go ahead.

Hey, Matt, Curt, Tammen, appreciate it. And thanks for having us here. I guess I'm going to touch quickly. obviously all of the input mechanics on ARPU, uplifting reduced churn leading to higher LTV, but also obviously seeing pretty healthy product strength across the portfolio. I believe part of that was channel led. To what extent maybe is that starting to be some of those strategic partnerships ramping, but also how that drives conviction as you get kind of more devices installed within each of the individual homes to drive that uplift and conversion. So maybe better clarity through better homes as a part of that product motion. Thank you. Yes, I think you hit on all three.

Yes, sorry about that. You hit on all three of the components of that. So one is we saw strength in the partner channel. I would say it was pretty typical buying if we look at kind of the seasonality in the partner area, but it was definitely strong. Kurt mentioned in the prepared remarks that we saw some strength in our retail and direct channel as well. Some of that is the full in of Amazon Prime just by a few weeks. And so that shifts just a tiny bit in quarter. But I would say in general, we've been capturing share and we've seen strength in the retail channel as we're continuing to see strength in the partnership channel. Both of those to your point, also are things that will have us look at higher ARR growth and service revenue growth going forward, because a lot of that's ending up in new households. The other topic you touched on is even when we sell these products into an existing household, you are correct in that when a household moves from one camera to two cameras or from two to three, the percentage of conversion or a cash on the service revenue side also goes up as well. So when we see unit volume actually increasing on a year-over-year basis. That is indicative of future service revenue and ARR growth.

Perfect. Thank you. Appreciate it, Matt. And then maybe for you or Kurt as well, too, I believe you guys called out some of the tariff savings maybe being utilized to reinvest more aggressively into the partnership motion. I guess can you just kind of give us some additional context into what that looks like? I know obviously some of these will ramp in the back half of the year and into 2027, but maybe what the incremental investment or the.

or spend can further unlock or accelerate in that motion. Thank you. Yes, yes, absolutely. Maybe just for clarity, we can kind of touch on exactly what we talked about on the call. So if you looked in Q2, we had about $8 million come in from a tariff-free fund, and that's roughly 7 cents of EPS as you drop it through to the bottom line. And as Kurt mentioned, we handedly and substantially so we beat the quarter even if you back that out. This quarter we're taking a different tact as the tariffs are coming in, partially because we can see it coming and it's a little bit more predictable. And it's roughly $6 million that's going to come in or call it what would have been 5 cents EPS. But when we look out at, that the investment of using this found gross profit coming into the company for investments, both short and long-term effect, the ROI is just so high. I just hosted last week, the executive team at an offsite where we talked about the second half and looked at our annual operating plan, which is the kickoff really for us to have this, have this planning process start and there are several areas where we find it exciting to kind of push into one is our you know our typical sales and promotional into the into the Q3 and especially the Q4 time frame so you'll see us lean in a little bit there as we see household formation really converting into subscribers. And we think leaning in there will expand shareholder value. Two is partnerships, Kurt touched on this. So the strategic partnerships, investing in the engineering on both our platform in general, and accelerating some of the things for our list to curate some of the technology we talked about next year, but also the integration and maybe speeding up the integration of strategic partners is beneficial to unlocking additional growth in 2027. And then I mentioned, and I think Kurt mentioned as well, the test. So we're looking at doing, and these are relatively small, but spending a little bit of money investment in Q3 to test some price points and channels for both our care from our allocators care acquisition and in the small business. And so you see us do that a little bit Q3 and a little bit more in Q4. And what we do is when we build our annual operating plans, we always like to have real data to base that off of. Um, and so this will not only look for. Additional revenue enhancement in the second half, uh, and maybe subscription revenue and subscribers, but really set us up to, to lock down a more cohesive plan based on real data for 2027, where we know at least in the care area, there's substantial, uh, uh, opportunities for growth. So when you step back and you say, well, why treat those two quarters differently? Again, we take our role as stewards of the capital of the company, of Arlo's capital, very, very seriously. And so when the tariff refund came in at the end of Q2, we looked at it and said, wow, there's opportunities to maybe spend and invest, but we don't have the time to actually do the rigor and the discipline of what would that ROI be and how fast would we see it for shareholders? So we decided to drop that down to the bottom line, like we talked about in the Q2 results. Q3, we have the time and we've had the time. And so we're going to use that smaller pair of rebate to fund very strategic areas of the business and explorations to drive, like I said, short-term growth and then what we call long-term growth, which really isn't that long-term, it's really in the next 18 months. So that's the numbers, that's the color commentary and the reason why you're seeing us do two different things from Q2 to Q3.

Terrific. Thank you, Matt. Appreciate it. You're welcome. Your next question comes from the line of Ryan Visson from Craig Hallam. Please go ahead.

Hey, Matt. Hey, Kurt. Ryan on for Tony Stoss. Thanks for taking my questions. Just quickly, I want to touch on AlloCare, the home helpers deployment. It seems like that was the first commercial expansion since you closed the acquisition. I guess, can you talk a little bit about how maybe that channel works, what the reception's been like from some of the care providers, and kind of how you're thinking about AlloCare runway into the future?.

next year? Thanks. Yes, great question. And you know, we did this, the Allocare acquisition for two reasons. One is the technology they have today and the technology roadmap, but also the pipeline of potential customers that we saw right before we did the acquisition. And that provides onsite support for numerous stay at home, elderly care providers. people out in the field. And they use the AlloCare technology to monitor the health but also communicate with the people in the field and be able to escalate and notify if there's something that needs to be corrected or somebody needs to be checked in on. So it allows them to scale their business. What we're excited about in this is not only just doing business with somebody like Home Helpers, but actually rolling out some of the new technology that Allocare has been working on for the last years include AI calling and AI check-ins, which is absolutely fabulous. We're hoping to demo this to the analysts at some point very soon, because it's pretty job dropping that you can provide AI call check-ins at a scale and provide all the feedback back into a dashboard for the caregivers, where all the feedback from that user is actually collated and you can start to predict issues in the future. So you start to build algorithms to predict falls or predict issues like dehydration of things, just from conversations that are having in the home. So two things, one, it's exciting that we're seeing the expansion of the Allocare business, even at this early stage, but two, seeing some of the most advanced technologies that Nobody Health has on the market be deployed through some of these partners. Now I mentioned on the call as well, I think HomeHulpers is an initial example of a partner that we've been able to announce very soon after the acquisition. You can expect several more, I would say, over the next maybe six to nine months be announced and not only add maybe a little bit of growth this year, but definitely set us up for some pretty substantial growth in the segment in 2027.

Perfect. Thank you, Matt. Congrats on the results, guys. Thank you.

Your next question comes from the line of Scott Searle from Roth Capital Partners. Please go ahead.

Hey, good afternoon. Thanks for taking the questions. Congrats on the quarter. Hey, Matt, we tended to talk about some of the strategic partnerships that you've established more recently, but we used to talk a little bit about some of the unpaid subscribers and potentially monetizing some of them as well. I think early on in some of the advertising trials, you were looking to use that to basically drive upsell opportunities. I'm wondering if you give us update in terms of monetization aspects on the unpaid subscriber base.

Yes, great question, Scott. So you're absolutely right. We've seen some very strong success in the advertising to non-pay subscribers of the services and subscriptions that we offer. look at advertising, we actually tested selling hardware, we tested selling services, and we tested third-party advertising. in that kind of free with ads, non-subscriber bucket. And the ROI was very clearly if you had, a user that actually signs up and the amount of users we were able to convert from actually, advertising and showing the benefits of our subscription services that our ROI was the highest by far. And so we've converted tens of thousands of subscribers from unpaid to paid just this year through advertising and being able to convert people over. And that's something you're going to see us continue to lean into and probably do more of. Where we get excited is actually starting to look at these households in more detail and maybe start to advertise allocare services in the future and some other opportunities to actually bring even more subscription conversion over time. The other one we have done historically off and on, and we're looking to do again, as we get into Q4 and the first half of next year is I mentioned earlier that we see subscription conversion jump when a single camera household moves to a two camera plus household. And so there's ways to promote through advertising or promote to that non-subscriber that has a single camera, a second camera on signup, and we see pretty healthy conversion in those kinds of offers as well. And so you'll see us experiment with a little bit more of that, both at the end of this year, but going into the first half of next year before our security launches.

Very helpful. And maybe to follow up on AlloCare, it sounds like you're starting to develop some incremental channel partners in terms of starting to deploy those types of services. I'm wondering where, I guess, self-install models, right, the DIY model fits for you with AlloCare. Is that something we start to see more of in 2027, how you're thinking about that?.