Arlo (NYSE:ARLO), a DYI security camera provider, reported Q1 2021 results on 5-May-2021, and they were outstanding. Revenue of $82.6M (+26.1% Y/Y) beat by $5.72M. Q1 Non-GAAP EPS of -$0.03 beat by $0.19 while GAAP EPS of -$0.13 beat by $0.18.
The company reported a plethora of incredibly strong fundamental business performance improvements across both product and services categories, and across the business in general. Most important of these were:
- Non-GAAP operating loss of only -$3.1 with guidance of non-GAAP breakeven in 2nd half of 2021.
- Accelerating total paid accounts to 549,000, +115% YoY growth and guidance confirming the target of over 1,000,000 total paid accounts by end of 2021. This will drive continued recurring revenue growth.
- Expanding total non-GAAP gross margin of 32.3%, +9.9% sequentially, and up by an amazing +24.9% YoY.
- GAAP product margin sat at 21.1% (versus -2.9% a year ago) and GAAP service margin sat at 57.9%, for a total GAAP gross margin of 31.13%.
- Strong results in Europe driven by the Verisure partnership, whereby paid subscriber attach rates are 1:1.
- Significant future opportunities in continued innovation of core camera capabilities and software service functionality as verified by management.
New SaaS Business Model
In my previous article, Arlo: A Growth Stock Underappreciated By The Investment Community, I outlined Arlo's new business model and growth opportunity. I advocated that Arlo would achieve 535,000 paid subscriber accounts in Q1 2021 - I was wrong.
They surpassed this figure to 549,000 paid subscriber accounts. Total revenue came in at $82.6M, +26.1% YoY. Software revenue came in at $22.8M, +54.8% YoY (I predicted $21.6M), and hardware revenue came in at $82.6M, +17.8% YoY.
Most importantly, management highlighted and reiterated that paid subscriber accounts are accelerating, with attach rates of 65% over a 6-month cohort.
With 4 quarters of verified results provided by the company, I believe it is time to declare Arlo's New Business Model an absolute success.
Driving To Sustained Profitability by Q1 2022
Due to the success seen across both product and services categories, Arlo expanded its gross margins to a non-GAAP figure of 32.3%, up +24.9% YoY. Most importantly, quarterly non-GAAP loss came in at just -3.1%.
Management firmly believes that non-GAAP breakeven will be achieved in 2nd half of 2021, and I have revised my models to demonstrate the impact of the Q1 2021 results on GAAP breakeven timing.
The key difference comes from the much better-than-expected product gross margins of 21.1%, instead of the 11.0% assumption used previously. Updating the model indicates the much improved gross margin profile the company will have in the coming years.
Source: Author's Calculations - Software Revenues ($M) and Impact on GM
The improved gross margin profile feeds profitability, demonstrating that positive GAAP EPS can be achieved as soon and as early as Q1 to Q2 of 2022.
Source: Author's Calculations - Software Revenues ($M) and Impact on GM
This contrasts with the previous calculation and modeling (prior to Q1 2021's results) that suggested the company would reach break-even and sustained profitability in Q4 2022 to Q2 2023. This is an improvement of potentially 2-4 quarters!
Projected revenues of $1.02B by end of 2025 with a total gross margin of ~41.5% and operating margin of 17.16% would yield $148.6M in net income and EPS of $1.86, assuming 80M shares outstanding. At the current share price of $6.50, this would imply a projected P/E of 3.50 by end of 2025.
Per Fidelity, Arlo is classified under the Information Technology Sector (P/E of 31.75 for this year's estimate) and under the Electronic Equipment, Instruments & Components Industry (P/E of 19.12 for this year's estimate). Per Yahoo Finance, Logi (LOGI) has a TTM P/E of 19.37. While ADT and REZI do not display a P/E, Alarm (ALRM) stock has a TTM P/E of 57.44. FLIR has a TTM P/E of 50.86.
A conservative P/E of 10 would imply a share price of $18.60 by end of 2025 or a 186% return from the current level. Using an industry P/E of 19.12 would imply a potential projected share price of $35.51 by end of 2025 or a 492% return from the current level. Arlo is a product leader in the DYI camera niche and may be able to command such a P/E, especially as it continues to win CES and other product awards in the coming years. You may refer to my previous article, which touches on Arlo's product leadership, product awards, and competitive advantages here: Arlo: Insiders Are Buying (NYSE:ARLO).
On the Q1 2021 earnings call, Arlo's management highlighted that much of the product revenue growth was driven by Europe as a result of continued strength from the Verisure Partnership. The B2B partnership is clearly a source of exceptional continued growth for the company for a number of reasons:
- Verisure has a commitment to purchase at least $500M of Arlo's products from 2020 to 2025, meaning that the numbers you see displayed in my models imply Arlo only needs to secure an additional $500M in revenue by end of 2025 - a very achievable goal that may ultimately be surpassed.
- Verisure deploys Arlo's solutions in retail and e-commerce in Europe, inclusive of TV ads for Arlo's products, essentially providing free marketing
- Verisure markets Arlo's brand in the direct channel for Verisure's Security Systems, whereby the attach rate for paid subscribers is 1:1
- Arlo is building a custom product offering for Verisure with full volume production expected to launch early 2022, whereby the attach rate is 1:1
The Verisure partnership alone demonstrates the competency of management and the strength of Arlo's expanding B2B partnerships, with any new partnerships that may be announced in 2021 to 2025 acting as added catalysts to fuel hypergrowth for the company.
It would be remiss of me to not also note the many existing and expanding paths to market for Arlo's products that exist to date.
Management Comments on Future Innovation
If you thought the story couldn't get any better - it does. Management reiterated via the Analyst Q&A that Arlo has significant future opportunities in continued innovation of core camera capabilities and software service functionality that it believes consumers would desire.
This means that one can expect future product releases and increased software functionality capabilities that will further drive new and incremental revenue for the company, while also strengthening the existing ecosystem focused on privacy and consumer safety.
Arlo's Q1 2022 earnings call demonstrated and verified the success of the new SaaS business model, now with 4 quarters of proven reliability, and will likely result in share price appreciation as the investment community slowly realizes the value of this hidden gem of a stock.
Results may be underappreciated by the investment community as the small-cap company is still flying under the radar. Stellar accelerating 115% YoY paid subscriber accounts growth is driving both services revenue and services gross margins upward (57.9%) and is providing a more reliable way to calculate and to evaluate the company's growth prospects. The spectacular improvement in product margins to 21.1% heralds a 10-minute round of applause for the company's management and employees for superb quarterly execution.
With $400M in revenue and 1M paid subscriber accounts to be reached by end of 2021, Arlo will continue its growth as a HaaS / SaaS business. The Verisure partnership provides $500M of baked-in revenue by 2025, leaving the company with plenty of opportunity to outperform my estimations of $1B in revenue by end of 2025. Any product or software service releases during that time frame will act as catalysts for hypergrowth of the company's business.
The company will likely reach break-even and sustained profitability in Q1 to Q2 2022, as opposed to my previous estimate of Q4 2022 to Q2 2023.
Arlo's growth profile appears to not have been fully factored into the share price, and the ongoing market correction provides an incredibly attractive entry-point to interested investors. Industry and sector P/E comparisons would indicate a potential projected share price for Arlo of $18.60 to $35.51 by end of 2025, or 186% to 492% share price appreciation from current levels.
Furthermore, management's insider ownership remains at a healthy level despite some profit taking by the CEO, CFO, and General Counsel. The CEO now owns 1.41M shares ($9.2M), the CFO owns 675K shares ($4.4M), and the General Counsel owns 379K shares ($2.5M). Sizable insider ownership of company stock is an excellent indicator for a spin-off and a small-cap company and demonstrates management's commitment to the future success of the business.
Investors, as always, are strongly encouraged to conduct their own research into Arlo before initiating a position. Feedback, questions, and commentary on this article are highly encouraged as Seeking Alpha discussions drive useful insight and cross-learning opportunities across the investment community and may reveal both positive and negative fundamental factors to be taken into account for the stock. Thank you for reading.