All right, packed house. Thanks everybody for joining. My name is Adam Tindle , and this is part of my connected devices coverage here at Raymond James. Very happy to have, Matt and Kurt, CEO and CFO from Arlo Technologies. Many of you may be familiar with their products. In fact, some of you may even be customers. It's been a very interesting story over the course of the company's life, significant evolution to more, services-centric business, and some, interesting, targets that they just introduced recently. So in terms of format, Matt's going to go through some slides for those of you not as familiar, probably about 20 minutes or so.
If you do have questions, encourage you to please raise your hand as we go, and then we'll save about 10 minutes or so at the end for additional questions. Matt?
Thank you, Adam. So I do have slides, but I'll try and go through them relatively quick. It's meant really as a backgrounder if you're new to the story or the market segmentation. So Arlo, if you're not familiar with who we are, we are actually, if you go way back, we're a spin from a company called Netgear that was in the wireless networking industry for routers and things like that. And Arlo was a technology that was built internally, stitched together with some acquisitions, and basically launched the first wire-free cameras in the world. And what we're focused on from a company strategy and vision perspective is really providing safety and security to people who mostly consumers, sometimes small businesses.
What we found is it's a very emotional product category. People use these products to protect the things that they care about most in their lives. And we've been on a journey over the last, I guess five, six years, especially in the first three years, of transitioning the company from basically a hardware company, which is what it was when we first spun out from Netgear, into a full recurring services business. And we've hit multiple inflection points. A couple of them I'll talk about today, but we're a completely different company than where we were maybe five or six years ago. The security industry or the safety and security industry is large.
Again, we play in several markets, but all of the markets are big, multi-billion-dollar areas, you know, hundreds of millions of households. When you look at certain damage or property theft, we're talking about large multi-billion-dollar issues that we're trying to solve, and the market is growing. And I'll show you a couple of slides on where the market's growing. From just a smart home security perspective, it's about 14% CAGR. When you look at video in particular, which we specialize in, it's closer to 20%. The whole global security market is going to reach over $50 billion when you look out about 4 or 5 years. So it's a fast-growing market.
There's a ton of tailwinds that are driving it, including some of the things on the previous slides. When you look at where damage is being done, you know, how people are feeling less safe, some of the trends we're just seeing on a global perspective, it's part of what's been fueling the overall growth of the industry and, and Arlo in particular. How do we separate ourselves? Number one, we build some of the best hardware in the world. Even though we're no longer just a hardware company, that's still very core to what we do, is we innovate, you know, very kind of rapidly when it comes to the hardware side, and we continue to do that. But it's really shifted to the software and services side as well.
One of the trends in the broader space has been the importance of video, and we're a video-first company as well. Today, people don't want to know if their front door opened. They want to know who opened the front door. They want instant gratification. They want to be able to interact with that person remotely. They want AI to be able to filter all the different notifications they get and only tell them or alert them on the ones that are most important. So a lot of the data, a lot of the analytics, a lot of the AI has become basically table stakes, and we're one of the leaders in the space. Launched our first AI services to consumers in 2018. So everyone's talking about AI for the last year or two.
We've been monetizing AI services in the consumer market since 2018. Here's a little bit of the innovation. So if you go way back, Arlo launched actually in 2014, nearly a decade ago. I won't go through all the different, you know, things that we've launched and innovated in the space, but you will see that smart AI that actually came out in 2018, that was, you know, five years ahead of where everybody else was in the market.
We have since launched additional services, and last week in our earnings call, launched or gave a sneak preview of what we call Arlo Secure 5, which is going to be the most groundbreaking AI service in the security industry, including private AI models on a per-user basis, where you can completely customize the system in certain ways, and a full recognition engine coming as well. And so we gave a little bit of preview. If you want to go back and learn even more about the company, take a look at the earnings release that we did on Thursday of last week. The core asset of the company is really the cloud platform that we've built.
So we have, most people don't know this, but we run one of the largest cloud platforms in the world, especially when you look at video and AI. As of today, this says 1,800 hours. It's almost 2,000 hours of video being uploaded per minute. That's about 2-3 times what YouTube is uploading per minute into their system. We have about 200 million-250 million videos a day. Every single one is being processed by our cloud back-end, and multiple AI object detection engines are running simultaneously across all those videos. So it is a large system. It's performant. It's built with security first, so it's, you know, not only secure, but it's very low latency, because if somebody's knocking on your door or somebody's breaking into a window...
You can't just upload the video and then process it. You need to process it in real time and be able to get notifications out in seconds, not minutes. So it's highly, highly performant, highly scaled, with AI and security at the core. And this is, again, what I would consider the asset of the company that we've built over the last 10 years. We're deploying it for consumer and small business, smart home security, but it could be adapted and used in many adjacent markets that we'll look at as we drive our growth over the long term. Little bit of the services, which is really the company today is a service company. We just crossed 3 million subscribers last week. That was an announcement we gave out on Thursday, the morning of earnings.
That's about a million subscribers up over the last year. So in March 2023, we had just crossed 2 million subscribers, and so now we're at 3 million. So we're adding subscribers somewhere between 150-200,000 per quarter. And so growing very quickly and adding subscription services. This is some of the metrics on our service business. So our ARPU, when you look at the consumers, which is the vast majority of our service revenue, people buy at, you know, Best Buy, and then they come to arlo.com and sign up after the free trial. We're running about $11.30 ARPU. Gross margin's almost 90% on that service.
When you take a look at the length of the customer relationship we have and calculate the long-term value of a customer, it's about $700. Our cost of acquiring that customer is about $100. So many of you that if you've done investments or you look at service companies, there's a ratio everybody looks at, which is LTV to CAC. You know, what is that customer worth on the long term, and how much did it cost you to acquire that customer? And that ratio tells you how healthy that business is. So one of the things we've done is, we've looked at, you know, how do we stack up versus some of the biggest brand names in consumer and SaaS services. And our 7 ratio, our 7-to-1 ratio, is actually best in class.
So we've built a really strong services business with great metrics underneath it. One of the things that's driving that $700 LTV is actually very low churn. So the other thing you look at in the services business is: How fast are you losing customers? It's like a hole in the bucket, right at the bottom. We have industry-leading churn as well when you look across different services. It's driven by a couple things. One, in this space, security and safety services are relatively sticky when you compare it to other services. Somebody may have two or three content services in their home. Maybe it's Netflix, Spotify, Disney, Paramount, whatever. And if they want to cut some pennies, maybe they cancel one of those. Households typically have one security service, right? You don't have multiple.
And because of the stickiness and because it's around you and your, your family and your house's safety, it's one of the least or the last items to maybe be canceled when somebody's trying to cut down on, on their expenditures. So it's, it's relatively sticky from a service perspective. Also remember that in many cases, a user has invested in some hardware as well. So maybe they've bought some cameras, they've got it all set up, so they're much less likely to then shut the service off. So what we have, what we've built is now 300 million... 3 million subscribers. We've crossed $200 million in annual service revenue at the end of last year. We're running at, you know, over $11 average revenue per user on a monthly basis.
We're running around 90% gross margins on that service, and we have industry-leading churn. So it's a best-in-class SaaS business that actually has been created after transitioning the business. We're actually proud of this. We just were named in Newsweek's Excellence 1000 Index, and we were one of the top 5 IoT companies that were named in that, and we shared that rank with Intel, Nokia, Verizon, and Microsoft. So again, we're a little bit lesser-known, we're a smaller company, but we're really punching above our weight in how we're executing in the marketplace and the recognition that we're receiving. Give you a little bit of history. I said we went through a transition, and this is a slide we shared last week, and just to show how far we've come.
What you see here is, on the left of each of the graphs, you have where we were in our IPO, and it's a little hard to read on the left and right. But IPO, if you look at, for instance, paid accounts, when we actually spun and separated the company, we had about 100,000 paid accounts. At the quarter end, year-end, we were at 2.8. As I said last week, we're already at 3 million paid accounts. So just massive growth. If you look at recurring revenue, we were about $10 million-$12 million, $13 million in recurring revenue at that point, and now we're at closer to $210 million in ARR as a business.
Profitability is, obviously, as we've reached scale in the services business and the service revenue and gross margin have mixed into our overall results as a company, we're seeing profitability expand quite quickly. Now, the mid graph you see here is LRP. We issued a long-range plan at the, it was March 2022, where we set out to actually show investors where we think this business was going, a couple of years ago. We set what we thought were really bold and kind of audacious goals as a company of reaching 5 million paid accounts within 5 years, $300 million in ARR, and lift the company above 10% operating margin. Well, the execution over the last 24 months has been so good, those metrics became kind of meaningless.
A lot of investors were coming to us and saying: "I don't even pay attention to your long-range plan anymore. You guys are clearly gonna eclipse it too early." So one of the things we did last week, and Adam had alluded to this, is we actually reset our long-range plan goals, pushed them out a couple of years, but raised them significantly. So we're now looking to approach 10 million paid accounts, $700 million in ARR, and actually get the company above a 25% operating margin in that time frame. Again, these are relatively bold. This is roughly a 3-5x where we sit today.
But the execution that we've been going through, that lift that you've seen through the, the company, the operating leverage we have in our business, lets us believe that we, will hit these metrics, inside of 2030. That's it. So that's a quick, quick run-through.
So I'll ask the first question, but definitely please feel free to bail me out. I've been doing firesides all day long. So, Matt, I think it was helpful to see the slide on services growth since the IPO. For those that are, you know, seeing those bar charts, it's just this, you know, astronomical growth rate. Maybe you can just explain a little bit of the drivers of that.
Yeah.
Talk about what the pricing model was, how you changed it, you know, and what was kind of the catalyst to drive that growth?
Yeah, I mean, it was a journey. Early on, when we were switching from, you know, a hardware company to a services company, we did a lot of research. You know, we looked at, back then, Netflix and some of the others were considered kind of best in class, and some of the only consumer services that were growing very quickly. And we had to change everything in the company. We changed the culture, we changed the roadmap, we changed how free trials work, we changed how the out-of-box experience happened, we changed the messaging. So it was basically a wholesale reinvention of the entire business model and the product stack, including really changing the thinking, the metrics that we measure ourselves with from a finance and operations perspective.
It took roughly two years, I would say, to get that, and then it took maybe another year for it to start showing through in the P&L. It was a three-year journey, and then what phase we're in now is what you're seeing is an acceleration. We've reached some scale. Last year, we changed our pricing model, so as we broke through 2 million subscribers, and our gross margin from services alone could cover the entire OpEx of the business. We leaned in and got a little more aggressive, and we actually brought hardware margin down, so we're targeting mid-single digits for hardware margin, but we brought service pricing up, so we kind of rebalanced our offering in the market. That drops the barrier of entry.
You know, it's less expensive now to buy a system and get it home and have this great experience, and then potentially sign up for service with us now. Give you an idea of the size of the transformation in the business model and some of what's happening with some of the pricing changes and things. When we spun from Netgear, you saw we had about 100,000 subscribers. That was about a 5% attach rate. So if somebody bought a kit at Best Buy or bought some hardware, there's a 5% chance that they would attach to a service tier. Now, we're closer to 60%-65% attach rate. So nearly two-thirds, after they have the system for a little bit of time and they get through their free trial, are actually attaching to service.
So again, a complete reinvention of the company, something we call services first, where we view the hardware, even though it's the best hardware, most innovative hardware in the world, it's really there to just instantiate that connection with the end user so that we can attach them to our cloud platform I talked about and start generating value for them through ongoing services.
Sorry, I have maybe obviously been thinking about how other, other companies, some similar.
Yes.
And then thinking about the Ring list and everything. Can you just compare a bit to where they are or what you, what you observe there? Because quite obviously, you've probably heard it 1,000 times, but Amazon, presumably...
Yes.
The elements to it, but, maybe that seems to...
Yeah. So, maybe talk about competitive landscape a little bit, which is kind of generally what the question you're asking. So early on, I remember when we spun, and we were still mostly a hardware business. It was, you know, Amazon and Ring and Google and Nest, the two behemoths, they're gonna crush you. And it turns out they're just not very focused on the space. They don't build great products, and so we were able to outcompete them in the early days on that frame.
What's interesting is then there was a thought of, well, you know, maybe an Amazon or a Google is gonna do so well with AI, especially recently in the last 2-3 years, that their budget, you know, they have 10,000 engineers writing AI algorithms and all the stuff, that they're gonna be able to roll out features that you don't have. Again, the same thing's happening, where our focus on the space, even with a smaller team, is producing much better solutions, better service, better AI, better, you know, better capability because we're focused in a space. Where they're trying to build this huge, multipurpose, generic AI engine, we're building specific AI engines to solve very specific problems, and it outperforms them dramatically. So it's the focus.
I would tell you another differentiation that's become key is our focus on data privacy. We're not a search engine or an advertising company collecting data from you, even though you're using, you know, our cameras. We're not trying to sell you stuff on an e-commerce site or something. We service our customers, and we feel your data is your data. We have a privacy pledge that totally separates us from other people or other competitors in the space. That's helped us with end users, it's helped us with retailers. I think this is more and more important, as you've seen, you know, issues, even with the biggest guys having security issues and partnerships.
So when we go and do some of our B2B business relationships, that idea, the way we structure our privacy and our data security, is light years above everyone else. So we've been able to out execute and out focus. This is not a side hustle for us. This is everything we do, and that's given us a competitive advantage that I think is actually broadening with some of the features we announced yesterday, last week. I think it puts us a couple of years ahead now of some of the bigger companies. We are seeing some consolidation. So we do see, you know, in Amazon and Google, they're starting to lay off people in these teams and get a little more defocused. And there used to be a lot of smaller brands in the space.
But once the solution moved away from just hardware, and it became actually services and software, and there's just a hardware component, most of the inexpensive hardware from Asia, ODMs, started to fall off out of the market. We're seeing that kind of shrink away. So last year, we actually captured share in what was kind of a difficult economic environment, and grew our business over 1 million, you know, basically, 1 million paid accounts in 12 months. So I think that when you look at an outlet, what's different is I don't think they ever reach scale, right? So what we saw is you need to get to about 1 million paid accounts to really have enough scale to start to accelerate.
And then when we hit 2 million paid accounts, we were able to kind of adjust our pricing, and we quickly got to 3 million. So we feel like we're kinda at that point of escape velocity, and our focus is really what separates what's our success, what's driving our success in the market.
I noticed on your subscription, you've tried to go from... I don't know where you started, but it was two months, now you're up to a month. Is that true?
For the free trial.
Free trial.
Yes.
What's the thought on that? How has it helped or hurt you?
Yeah.
Just tell me about how the subscription stuff works. If you go to the store, do you buy it on the offer? 'Cause it's unbundled or how?
Yeah. So great question. So the experience is, I mean, there are some people that come through e-com, or they actually are looking for a service, and then they figure out what hardware they want. But when you look at a traditional retail channel, it's usually somebody on the shelf, and they're buying the hardware first, is kind of the thing that they're, you know, the mentally first step that they're taking. So they'll buy the package. Often we sell, like a three-camera kit, is one of our most popular SKUs, for instance, at a Best Buy. They take it home, they install it. It's extraordinarily easy to sign up. So one of the innovations that we brought to the market was true DIY.
So you can use an installer and, you know, Geek Squad, but our products, usually you can set up each camera in less than five minutes. It's extraordinarily easy to set up. To your point, originally, we had a 90-day free trial, and part of that was a negotiation with the retailers. As we were changing our business model, they wanted the free trial to be longer than the retail return period, 'cause just for risk association, if we were making the business model change. What we found out over time was that 90 days is just, it's too long. It doesn't, it doesn't need to be that long. People were making their mind up around service in 30 days. So why give three months of free service?
And in fact, we found that the free trial was so long that people forgot it was a free trial 'cause it was almost too long. It was actually causing negative associations with it. So we moved to 30-day, about a year and a half ago, almost two years ago, and it's actually been... We have higher conversion rates, and we actually have less complaints. So you get a free trial. We provide a free trial of the entire stack of services, from professional monitoring, cellular backup, battery backup, all of our AI capabilities, cloud storage, and all the other features that we have. So you get to experience the full feature set and user experience of what Arlo is at its maximum.
Then when the free trial is over, that shuts off, and you have, if you don't sign up, you have basically a live camera with simple motion notifications. The difference in experience is dramatic. This is one of those areas where, being a subscriber and the user experience of all of what the service provides is quite valuable, and I think that's what drives such a high attach rate to the service.
I have a silly question.
Yeah.
One that comes to mind. When you watch some of these shows, whether they're police shows or whatever, they have these cameras, but the quality is so bad, you can't really tell what the person looks-
Yeah.
like that picture.
Right.
How has that changed, and are you able to afford it?
Yeah, so, video quality, most of those old cameras or some of the footage you see is, it's an old analog camera with analog cables that have been mounted, you know, 20 years ago or something. All of our cameras are... Most of them are battery-operated, by the way, as well. That makes it so easy to install, Wi-Fi. Our lowest resolution camera-
Wi-Fi is still,
Well, we have cameras that actually can switch radios over to SecureLink and continue to connect over our hub that has cellular backup if you, if you want, like, a full experience like that. So they're resilient to power outages, they're resilient to network outages and the like. Our lowest resolution camera is actually 1080p, full high def, and then we are still one of the only camera manufacturers that go all the way up to 4K with full high definition, high dynamic range, capabilities and low light capabilities. So, for our cameras, you can zoom in on a car across the street and read the license plate.
So how does that delve into your commercial side of the... Talk about that.
Yeah, so, we're really focused on consumer-
Quality
- and small business, and that's where we're focused to reach the metrics that you're seeing there today. There are many adjacencies, I think, you know, over the next, call it 3-5 years, as part of our long-range plan, that we're exploring to go into and leverage that platform into other markets. But right now, we're not in kinda commercial enterprise, even though we have the capabilities of those systems. I would say even small business, most of our small business we're addressing through, like, Costco and Amazon. We're not-- We don't have a reseller of our network yet. There are other verticals that I think are very exciting, including the insurance industry, which is very much trying to bring more data analytics to what they do from a risk mitigation perspective, data analytics, understanding the customer better.
A lot of what they've done with driver safety score , if you're familiar with what they're doing with the driver safety apps, they wanna do in the home, and they're looking for partners. So that's a vertical we're excited about. Other ones, like Age in Place, where, you know, we have a secure network, we have secure sensors in the home, and our entire cloud Platform is already plugged into emergency services. So, you know, there's some kind of a natural adjacencies that we'll be exploring, but today it's really the consumer market with some SMB, and we're focused on reaching that, that 10 million subscriber count.
So you laid out aggressive growth plans. I understand the service side is more like a major visibility, but what gives you confidence you can actually hit those goals? And what sort of metrics we should look at that you have the visibility in your sales growth?
Yeah. Yeah, you want to talk about how the model was built up?
Yeah, I can give you some details. But first let me say that, you know, when we built the model for those long-range targets, we looked at multiple paths to get there. Obviously, the most relevant one we focused on was just organic growth, and what we did is we kind of took a historical perspective and applied some of those assumptions going forward. It started with pretty conservative assumptions around the growth in the market and our ability to take market share. Right now, we're assuming about a 1.8%-2% growth overall in the market, which is nominal, obviously even below inflation right now. We also assume there would be modest to low share gain.
You know, we have seen over the last year market share gains, but our feeling was that that may continue in the early part of that 5- to 6-year window, but generally, we assume stable share positioning. And then what we did is we looked at some of the learnings we had from this past year. You know, when we made the price change in the February timeframe, we increased pricing across our services planned anywhere from 20%-30%. And we were amazed at how low of an impact that had on our overall churn rate. In fact, it may have ticked up 1 or 2 points, but then came back down and has leveled off to where it was historically. So our feeling is that we do have pricing power, assuming there is value in the packages.
And so, as Matt talked on Thursday at our investor call, the innovation cycle that we see over the next 5-6 years will allow us to either increase the packages and value and help people move up the stack in terms of service plans, or give us the right to increase pricing once or twice over that 5-6-year window. So you factor all of these in, given our CAGR that we had had for the last, you know, 3-5 years, you add it all to the mix, and it pretty much came out to, if we continue on the pace that we're currently at right now with subscriber growth and our pricing trajectory, we'll hit those two targets clearly.
And given our OpEx and the need to increase OpEx is fairly minimal, the 25% operating margin is quite, quite straightforward to achieve. So, I mean, much more detailed than that, but high level, we looked at it through the lens of, first, subscriber growth, what we can do there. Second, on what do we have in terms of pricing power? And then third, what does our OpEx structure look like over that period of time, and can we keep things relatively constant year-to-year?
So what you're not hearing, we have to do something.
Maximum
... you know, substantial to get there. I think when we and this is how we attacked our first long-range plan. The question for us as a management team and executive team is: how do we get there faster? How do we actually, you know, be at, which we did, which is great, and then we set higher goals. And what, how do we want to deploy capital? So one of the new conversations we're having now that we're throwing off a lot of cash, our cash balance is rising up, is: how do we actually trigger even faster growth? And so we're going through a process with the board. We have a strategic committee, and we're talking about capital allocation.
Some of it will be organic to feed some of the things we're talking about on an R&D perspective, potentially additional marketing when the market kind of recovers, maybe in 25, and start to do some more high funnel tactics to drive more awareness. But there could be some inorganic as well. There's kind of a window open up where there is some market consolidation. There might be an ability for us to, you know, acquire some customers or interesting piece of technology. So we're going through that assessment right now, but none of that's required to actually achieve the numbers in our current plan. It would be to see if we could achieve those earlier.
For what it's worth, we had another large smart home company earlier today in a different part of the market, also talking about raising prices. So it does sound like the competitive dynamics are quite healthy.
Yeah
... in the smart home market.
Yeah, and Adam, the other thing I would say is, you know, one of our competitive sets is traditional security. So the ADTs, the Vivints, the Brink's of the world, we're capturing share from them because people want to move to a more visual, more robust, more feature-rich solution. But typically, even those lower type systems, they're charging $50-$60, sometimes $70 a month. Our highest price tier right now, highest price, is $25. So, you know, there is room to continue to innovate, add new features, and potentially do price moves over time, because we're still substantially below what traditional security is.
It's a great summary. We're going to leave it there and continue the conversation downstairs.
Okay.
Matt, Kurt, thank you so much.
Oh, great. Thank you.