Ladies and gentlemen, thank you for standing by. At this time all participants are in a listen-only mode. [Operator Instructions] I would now like to turn the conference over to Erik Bylin. Please go ahead, sir.

Thank you, Atisia. Good afternoon, and welcome to Arlo Technologies Third Quarter of 2019 Financial Results Conference Call. Joining us from the company are Mr. Matthew McRae, CEO; and Ms. Christine Gorjanc, 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 third quarter along with guidance provided by Christine. We'll then have time for any questions. If you have not received a copy of today's press release, please visit Arlo's Investor Relations Web site at www.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 expected revenue, gross margins, operating margins, tax rates, expenses and future cash outlook, continued new product and service differentiation and future business outlook. 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 mentioned on the call. A reconciliation of the non-GAAP to GAAP measures can be found in today's press release on our Investor Relations Web site. At this time, I would now like to turn the call over to Matt.

Thank you, Erik, and thank you everyone for joining us today on Arlo's third quarter 2019 earnings call. We have a lot to cover today in what was an outstanding quarter for the company from an execution perspective. Christine and I will walk you through the major elements including financial results for the quarter, our definitive agreements with Verisure, launch of Arlo Pro 3, announcement of our first video doorbell, implementation of a comprehensive restructuring plan and the closing of a $40 million line of credit. Let's start by talking through some highlights for the quarter. In Q3, we achieved $106.1 million in revenue above the high-end of our guidance for the quarter. Services revenue was $11.8 million, which represents a year-over- year growth of 20% and a new record for the company. We added about 294,000 registered users to the Arlo platform in Q3 to reach a total of nearly 3.7 million total registered users up 48% year-over-year. More importantly, our paid subscriber base continues to grow at a faster pace and reached approximately 211,000 users up more than 69% from a year ago. As a reminder, this growth does not include our Arlo Ultra and now our Arlo Productivity 3 customers buying products with our new services business model that includes a limited free trial of Arlo Smart. We believe when the trial period for Arlo Smart lapses, many of these customers will subscribe to Arlo Smart and we will see further acceleration in the growth of the paid subscribers in the first half of 2020. Today, I'm excited to announce that we have entered into a truly impactful strategic partnership with Verisure that has multiple benefits to Arlo. Verisure is a leading provider of professionally monitored security solutions with 3 million customers in 16 countries across Europe…

Thank you, Matt, and thank you everyone for joining us for our third quarter of 2019 earnings call. Before I discuss our financials, I would like to provide some detail on our restructuring in line of credit. As Matt mentioned, today we announced a restructuring plan that has already allowed us to materially lower our operating expenses in Q3 '19 and under which we will continue to see benefits into 2020, importantly this will not hinder our ability to deliver market leading innovation to consumers. The guidance we gave for the third quarter and full year implied on an operating expense level of approximately $40 million per quarter. Our restructuring plan will lower our ongoing non-gap operating expenses to an annualized run rate of approximately $33 million to $34 million per quarter, saving approximately $25 million per year compared to our expectation of $160 million. Due to these actions, we will encourage charge totaling approximately $1 million to $2 million over the next few quarters. These cost savings will be fully actualized by the second quarter of 2020, but as I mentioned, we already began to see their effect in Q3. We expect some variability in our quarterly operating expenses, mainly due to our allocation of channel marketing expenses between contra-revenue and operating expenses as well as other seasonal expenses. These savings include but are not limited to reducing outside services, headcount, infrastructure and marketing activities. They also include savings that we will realize based on the Verisure deal. Additionally, we have secured $40 million revolving credit line based on our receivables. We may use these funds to supplement working capital as needed. As previously disclosed in April 2019, the company's Board of Directors commenced a comprehensive strategic review of the company. On November 7, 2019, the company announced that…

[Operator Instructions] Your first question comes from the line as Adam Tindle from Raymond James.

Okay, thanks. And good evening. Christine, I think I just wanted to start maybe on that last comment and kind of a more near-term question on the product side. Q4 revenue, I know it was a pretty high bar to start, but it's going to come down by over 20%. So, maybe just what is different from your expectation? Heading into this channel inventory was supposed to be lean, you thought you had two new products in the quarter, which typically don't get two new products in a single quarter. So, that would lead to a big sequential up tick. I know that $15 million chip shortage is going to lead to some of the deltas but not all of it. So just trying to get to the bottom of, what on top of the chip shortage is driving the incremental delta from your expectations.

Sure. I think when we look at the full delta it's really some of the orders are slipping into Q1. Some of it is really, we have seen some increased demand and it's really mixed at that point coming in at the mix and bringing products in. So, between the two that probably gets close to the delta.

Okay. I mean, and maybe a question for Matt. Is there any aspect of seeing pushback on the new business model that does not include services leading to lower product sales or is that just not happening?

No. We don't see any issue there at all. The product we described at short is actually an older product. And we're making moves to try and fill as much as that as we can, which is part of the impact on gross margin, but we're not seeing any issue in the shift to the new business model.

Okay. Good to hear. I want to touch on Verisure professionally monitored security company. I just want to understand the economic aspects of the deal, understand not fully closed and maybe still negotiable, but any help you can give us. One of the terms is the 500 million contingent on anything or is it fully committed with the gross margin on that 500 million is how we can think about the economic aspects of it.?

Yes. Well, I think what we can share with you from the high level, is what we talked about around them purchasing the commercial operations for 50 million and then having a minimum guarantee of the 500 million across various products. Now if you, it's interesting, if you look at the European market that market for us is $50 million roughly in revenue today and that market's growing at about 5%. Now with the 500 million guarantee over the next five years, that's suggesting a CAGR locked in at 24%. So, you're seeing a good deal of growth. Now, what I'll say from a just a kind of informational perspective is a lot of that growth you'll start to see in the second year of the deal. So, 2021 going forward because the first year, we've got some developments, some integration to do before you start really having the full impact of that. But the 500 million is the minimum guarantee over the five years, suggesting that that strong growth of 24% CAGR in that region. Now that compares to kind of the rest of world or if you look at the category in total on a global basis where we're seeing growth roughly in the 5% to 10% range. And of course, as we look forward into 2020, we're targeting to outgrow the market there. And based on our new products, like the full year on the doorbell and a couple of products that will be announced next year, we're targeting growth more like 10% to 15% above that category growth market when you compare it to our 2019 full year guidance.

Okay. That's helpful on the timing. And then, maybe just on the margin front of it, do you, do you participate in any of the RMR from professional monitoring with it or is this just all basically product resale to them and is it accretive to your current product margins? Is it dilutive? Just any ballpark on how we can think about the gross margins on that 500 million over time?

Yes. So, what I can comment on is, the 500 million guarantee over the next five years is really hardware purchases. But the deal also encompasses all of our Arlo Smart services including computer vision and the like. And in fact, they're going to deploy the product through multiple channels and through their direct channel, every customer buying an Arlo product will actually have service attached. So, we think this will actually serve as an acceleration of our subscriber in [RMR] [ph] market by this great partnership we have with Verisure, who really understands how to sell services in a professional and an innovative way into the market that they're strongest and which includes obviously the European territory. So, we're not commenting on gross margins in detail, but I did say in the script, if you remember that as we look at this deal going forward, not only is the $50 million business in Europe going to grow based on their investment and based on the 500 million guarantee just on the hardware side, but we see profitability actually growing from that standpoint over the five years as well.

Okay. That's fine. Maybe just one last one, on the Arlo Smart trial, it's going to lapse in early 2020 for the first tranche. Any way that you can help us with how you're thinking about, potential for incremental subscribers versus churn, any help with the potential incremental services came from that opportunity would be helpful.

Yes. So, when we look at the current business model, which you're right, is still being rolled on the products we're selling today. I think we've commented in the past that people who try the service are attaching in a healthy, I think we use the term manner and that our turn is actually also healthy. So, we're using that to model what we think is going to happen next year. We don't -- there's nothing that we're actually sharing at this point but based on what we're seeing in the current models, we expect to see an acceleration, especially as we kind of execute one and start to look on the first full quarter of having people on new business models for several of our products. And to that point, we've had Arlo Ultra for the last six months or so, really on this new business model. And Arlo Pro 3, which we announced today is on a shorter version of that same business model, only 90 days. And the video doorbell that we announced today is also on that 90-day trial. So, we're really looking at in kind of that Q1 to kind of Q2 timeframe to see what that lift will be. All indications is, it will be a decent lift and we're looking forward to reporting that.

Okay. One final clarification on the Verisure, you had mentioned in the response to the question that they're going to -- Arlo Smart is going to be lumped into that, is that also a one-year free trial for those customers? Is it an ongoing, how does the Arlo Smart piece work with the Verisure relationship?

Yes. So those products sold through the existing retail channels, we'll at this point mimic what you see here in the United States. So, there'll be -- the new business model and the new products and it will flow through, in a similar way. For those products sold through the Verisure direct channels that'll be actually encompassed into the Verisure service package. And so, they will be signing up for kind of a contracted service. That includes Arlo Smart for those products that are Arlo developed and manufactured and sold to Verisure

Interesting. Okay. Thank you very much.

You're very welcome.

And our next question comes from the line of Hamed Khorsand from BWS Financial.

Hi. So, first question I had was what kind of changes are you making this quarter specifically Q4 to offset those shortages in Pro 2, I guess is there any marketing a kind of strategy push the customer buy Pro 3 and Ultra?

Yes. So pro 2 obviously the shortage came in pretty, pretty late from a notification perspective. And what we've been doing is working with our partners from a channel perspective in leveraging other products like Ultra and Pro 3 into some of those promotional opportunities.

Okay. Are you going to pull back on some of the doorbusters? I know Best Buy's been advertising your Pro 2 as a doorbuster for Thanksgiving weekend. Is that going to change up now because of the shortfall?

I think you'll see that continue. It's just the number of units potentially sold because of the shortfall of supply. It's different than what we obviously expect to coming into the quarter.

Okay. And when I'm having difficulty is, obviously you have better margins here if you should sell Pro 3 and Ultra, right? So, isn't there more of a emphasis to move the customer higher instead of just…

I mean, we'll probably give them a little bit deeper discount on that, but then we also will get the service revenue for that when it turns around into Q2.

Yes. The other issue that'll hit is because we're having to bring in product at the last minute to fulfill some of the retailer demands freight and some other things are a little bit more expensive.

Okay. And then once you -- we go into Q1, Q2. Do you think you'll have enough supply to get gross margins back, at a highest level?

Yes, absolutely. What will be back in stock and get the Pro 2 by mid-December in full.

Okay. Thank you.

You're welcome.

And your next question comes from the line of Thomas Boyes from Cowen and Company.

Thank you very much. I just had a couple quick ones. I was wondering what the feedback you've had from the direct-to-customer sales through arlo.com and really how that matured over the past quarter.

Yes. It's been a great start. I mean obviously we launched a rather simplistic version of the site, but it did beat all of our kind of internal goals and it's something that we'll obviously continue to invest in as we go forward and into 2020. What's interesting is not only do we view that as a incremental revenue opportunity and obviously potential path to higher gross margins. It's also an area where we can explore new business models' potential bundles and other things and kind of a low risk manner before rolling that out in scale to some of our channel partners. So, it's been -- we would call it a great success, starting from zero. And it's something we're going to continue to build over time.

Great. And how has the competitive environment changed for the last several months? Have you seen any of your other competitors start to offer a E911 services or anything like that and geographies that you compete in?

We haven't seen a lot of news in that area. I think there's been a couple of announcements of some -- maybe one or two of the features being launched or maybe rolled out next year. But as we sit here today, Arlo still is the only company that has that suite of services that we have in Arlo Smart. And of course, we have a roadmap to add additional services over time, over the next couple of quarters and as we get into 2020. So, we're not standing still. I would expect now that we've had Arlo Smart in the market for a year, almost a year-and-a-half as we get to the end of this year. Some of those original features could start appearing on other products, but like I said, we're going to continue to March forward and have a whole roadmap on, on adding additional compelling features to that to drive not only additional subscribers from a number and revenue perspective, but also, in the future look at potential opportunities to increase ARPU through adding more advanced features in the future.

Great. Then I think I understand the revenue component of the guidance well enough with the 15 million delta then mix obviously explaining the rest of it. Could you just tell me a better understand maybe the margin impacts relatively maybe where I think expectations were heading into the quarter? Is that just a greater degree of promotions that's causing that expectation delta?

Yes. I mean, starting with, it's our most -- we promote more in Q4 than any quarter, but definitely as we're substituting some other products, for example, Pro 3 for Pro 2, we're promoting that more heavily. So that does affect the margins, which I mentioned in the script. And then, also during Q4, we do have the freight -- additional freight because we are bringing over Pro 3 and doorbells and all that NPI products and new products are coming over via freight.

Excellent. And then just one last one, a really quick what would your cash expectations need to be kind of looking into 2020 post the Board's review, the strategic review and understanding what kind of the cost of niche that you're already working [indiscernible]?

I mean, if you think about it, we're ending this quarter with $154 million, we have access to another $110 million. And so, I think when we look at that, we would always like to have $100 million. So, I think we're pretty pleased with the work that's happened this quarter.

Excellent. Thank you very much.

[Operator Instructions] And there are no further questions at this time. I will now turn the call over to Matt McRae for closing remarks.

Thank you everyone for joining us today on what you can tell us a significant quarter for Arlo. The announcements today represent the culmination of actions and execution taken since our spin from Netgear, the strong financial performance, the successful, and on-time launch of Pro 3, our announcement of the video doorbell, the multifaceted strategic deal with Verisure providing a cash infusion and future revenue, our restructuring plan and the revolving credit facility have put Arlo on a solid ground to execute our business plan. The team here continues to be maniacally focused on operating the company in a focused, efficient and disciplined manner as we diversify the business and capture growth opportunities across markets. Thank you.

And this concludes today's conference call. You may now disconnect.