S-1/A 1 d463504ds1a.htm AMENDMENT NO. 1 TO FORM S-1 Amendment No. 1 to Form S-1
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As filed with the Securities and Exchange Commission on July 23, 2018

Registration No. 333-226088

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Amendment No. 1 to

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

ARLO TECHNOLOGIES, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   7370   38-4061754

(State or other Jurisdiction of

Incorporation or Organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

350 East Plumeria Drive

San Jose, California 95134

(408) 890-3900

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

 

 

Matthew McRae

Chief Executive Officer

350 East Plumeria Drive

San Jose, California 95134

(408) 890-3900

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

With Copies to:

 

Andrew W. Kim
Senior Vice President of Corporate Development, General Counsel and Corporate Secretary

NETGEAR, Inc.
350 East Plumeria Drive
San Jose, California 95134
(408) 907-8000

 

David C. Karp
Ronald C. Chen

Wachtell, Lipton, Rosen & Katz

51 West 52nd Street

New York, New York 10019

(212) 403-1000

 

Jack T. Sheridan

Tad J. Freese

Brian D. Paulson

Latham & Watkins LLP

140 Scott Drive

Menlo Park, California 94025

(650) 328-4600

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after this registration statement becomes effective.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box.  ☐

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act of 1933, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 under the Securities Exchange Act of 1934:

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer      Smaller reporting company  
     Emerging growth company  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.  ☐

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered

 

Proposed

Maximum

Aggregate

Offering Price(1)(2)

 

Amount of

Registration Fee(3)

Common stock, par value $0.001 per share

  $234,945,000   $29,250.65

 

 

(1) Includes additional shares of common stock that the underwriters have an option to purchase from the registrant.
(2) Estimated solely for the purpose of computing the registration fee in accordance with Rule 457(o) of the Securities Act of 1933, as amended.
(3) The Registrant previously paid a registration fee of $12,450.00 in connection with the initial filing of this Registration Statement.

 

 

The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to such Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the U.S. Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities, nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion

Preliminary Prospectus dated July 23, 2018

10,215,000 Shares

PROSPECTUS

LOGO

ARLO TECHNOLOGIES, INC.

Common Stock

 

 

This is an initial public offering of common stock of Arlo Technologies, Inc., currently a wholly owned subsidiary of NETGEAR, Inc. We are offering 10,215,000 shares of our common stock, par value $0.001 per share.

Prior to this offering, there has been no public market for our common stock. We expect the initial public offering price of the common stock to be between $18.00 and $20.00 per share. We have applied to list our common stock on the New York Stock Exchange (“NYSE”) under the symbol “ARLO.”

We are an “emerging growth company” as defined under the federal securities laws and, as such, have elected to comply with certain reduced disclosure requirements for this prospectus and may elect to comply with certain reduced public company reporting requirements for future filings.

Investing in the common stock involves risks that are described in the “Risk Factors” section beginning on page 24 of this prospectus.

 

 

 

    

Per Share

    

Total

 

Public offering price

   $      $  

Underwriting discount(1)

   $      $  

Proceeds, before expenses, to us

   $      $  

 

(1) See the section titled “Underwriting” beginning on page 169 of this prospectus for additional information regarding total underwriter compensation.

The underwriters may also exercise their option to purchase up to an additional 1,532,250 shares from us, at the public offering price, less the underwriting discount, for 30 days after the date of this prospectus.

Neither the U.S. Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares against payment on                     , 2018.

 

 

 

BofA Merrill Lynch   Deutsche Bank Securities   Guggenheim Securities
Raymond James   Cowen   Imperial Capital

 

 

The date of this prospectus is                     , 2018.


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TABLE OF CONTENTS

 

    

Page

 

PROSPECTUS SUMMARY

     1  

TRADEMARKS, TRADE NAMES AND SERVICE MARKS

     19  

INDUSTRY AND MARKET DATA

     19  

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

     21  

RISK FACTORS

     24  

USE OF PROCEEDS

     62  

DIVIDEND POLICY

     63  

CAPITALIZATION

     64  

DILUTION

     66  

SELECTED COMBINED FINANCIAL DATA

     68  

UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS

     71  

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     78  

BUSINESS

     100  

MANAGEMENT

     123  

DIRECTORS

     125  

EXECUTIVE COMPENSATION

     130  

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     143  

PRINCIPAL STOCKHOLDERS

     156  

DESCRIPTION OF CAPITAL STOCK

     157  

SHARES ELIGIBLE FOR FUTURE SALE

     164  

MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES FOR NON-U.S. HOLDERS OF OUR COMMON STOCK

     166  

UNDERWRITING

     169  

VALIDITY OF COMMON STOCK

     177  

EXPERTS

     177  

WHERE YOU CAN FIND MORE INFORMATION

     177  

INDEX TO COMBINED FINANCIAL STATEMENTS

     F-1  

You should rely only on the information contained in this prospectus or contained in any free writing prospectus filed with the U.S. Securities and Exchange Commission. We have not and the underwriters have not authorized anyone to provide you with any information other than that contained in this prospectus or in any free writing prospectus prepared by or on behalf of us and filed with the U.S. Securities and Exchange Commission. We take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. We are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where such offers and sales are permitted. The information in this prospectus or any free writing prospectus is accurate only as of its date, regardless of its time of delivery or the time of any sale of shares of our common stock. Our business, financial condition, results of operations and prospects may have changed since that date.

Until and including                  , 2018 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

 

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PROSPECTUS SUMMARY

This summary highlights certain information about us and this offering contained elsewhere in this prospectus, but it is not complete and does not contain all of the information you should consider before investing in our common stock. In addition to this summary, you should read this entire prospectus carefully, including the risks of investing in our common stock and the other information discussed in the section titled “Risk Factors,” and the financial statements and the related notes included elsewhere in this prospectus, before making an investment decision. This summary contains forward-looking statements that involve risks and uncertainties. Our actual results may differ significantly from the results discussed in the forward-looking statements as a result of certain factors, including those set forth in the sections titled “Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements.”

We describe in this prospectus the businesses that will be contributed to us by NETGEAR as part of our separation from NETGEAR as if they were our businesses for all historical periods described. Please see the section titled “Certain Relationships and Related Party Transactions—Relationship with NETGEAR—Arrangements between NETGEAR and Our Company” for a description of this separation. Our historical financial results as part of NETGEAR contained in this prospectus may not reflect our financial results in the future as a stand-alone company or what our financial results would have been had we been a stand-alone company during the periods presented.

As used in this prospectus, the terms “Arlo,” the “Company,” “we,” “us” and “our” may, depending on the context, refer to Arlo Technologies, Inc., to the Arlo segment of NETGEAR, Inc. as described more particularly under “Certain Relationships and Related Party Transactions—Relationship with NETGEAR—Historical Relationship with NETGEAR” or to Arlo Technologies, Inc. and its consolidated subsidiaries after giving effect to the separation described under “Certain Relationships and Related Party Transactions—Relationship with NETGEAR—Arrangements between NETGEAR and Our Company.” As used in this prospectus, the term “NETGEAR” refers to NETGEAR, Inc.

Overview

Arlo combines an intelligent cloud infrastructure and mobile app with a variety of smart connected devices that transform the way people experience the connected lifestyle. Our cloud-based platform creates a seamless, end-to-end connected lifestyle solution that provides users visibility, insight and a powerful means to help protect and connect with the people and things that matter most to them. Arlo enables users to monitor their environments and engage in real-time with their families and businesses from any location with a Wi-Fi or a cellular network internet connection. To date, we have launched several categories of award-winning smart connected devices, including wire-free smart Wi-Fi and LTE-enabled cameras, advanced baby monitors and smart security lights. In addition, Arlo’s broad compatibility allows the platform to seamlessly integrate with third-party products and protocols. Since the launch of our first product in December 2014, we have shipped over 7.5 million smart connected devices, and, as of April 1, 2018, our smart platform had over 1.9 million registered users across more than 100 countries around the world. We plan to continue to introduce new smart connected devices to the Arlo platform in new categories, increase the number of registered users on our platform, keep them highly engaged through our mobile app and generate incremental recurring revenue by offering them paid subscription services.

Arlo exemplifies a new generation of smart internet-of-things (“IoT”) platforms by featuring smart devices that are always connected to the internet, software developed with artificial intelligence (“AI”) capabilities, including machine learning and computer vision, and a highly engaging mobile app through which users can manage and utilize their smart connected devices. We believe we are well-positioned to capture the large and fast-growing connected lifestyle market opportunity by leading the way into this new generation of connected lifestyle platforms.



 

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Our total addressable market consists of individuals and business owners who use connected devices to enhance their lives. According to Gartner, consumer IoT endpoints hardware and services spending will reach $1.8 trillion by 2021.(1) Gartner estimates our addressable market for the global connected home alone, including elements of consumer IoT services spending and IoT endpoints hardware spending, will grow from $45 billion in 2017 to $146 billion in 2021, representing a compound annual growth rate (“CAGR”) of 34%.(2) Outside of the home, we have seen adoption of our cellular-enabled products in a variety of use cases, such as neighborhood watch, construction site monitoring, wildlife and outdoor trail surveillance and event monitoring. We are also seeing demand for our products and solutions from small businesses and local government agencies, and believe these segments represent additional growth areas for us. According to NPD, for the second quarter of 2018, we held 48% market share based on dollar sales in the U.S. consumer network connected camera systems market.(3)

A user’s introduction to our smart platform typically starts with the purchase of one or more of our cameras and lights. Consumers and business owners can easily set up these smart connected devices by downloading our mobile app and integrating these devices into their homes and businesses without the need for professional installation services. The Arlo app provides users with a highly engaging experience through real-time motion detection notifications and live stream functionality. To realize the platform’s full potential, users can subscribe to Arlo Smart, a paid subscription service that adds powerful AI capabilities to Arlo cameras that enhance the user experience by providing users with actionable intelligence and rich app notifications. These Arlo Smart services are available via three subscription-based tiers: Arlo Smart Premier, Arlo Smart Elite and Arlo Smart Add-On, each more fully described below under “—Our Products—Arlo Services.”

Our fully integrated smart platform provides an intuitive and engaging user experience, which distinguishes our product offerings and contributes to our rapid growth. According to Sensor Tower, for the first quarter of 2018, the Arlo app had a user engagement rate, measured by daily active users (the number of users who launch the Arlo app at least once per day on average in a period) divided by monthly active users (the number of users who launch the Arlo app at least once per month on average in a period) of 37%. Sensor Tower’s data also shows that, during the same period, the Arlo app’s number of daily active users was in line with the median of the 500 most downloaded apps from the Apple App Store and that the Arlo app had a user engagement rate in the top 6% of these apps. While not one of these 500 apps, the Arlo app’s user engagement rate compares favorably to many of the most engaging social media and entertainment apps available. We believe our high user engagement rate is driven by the combination of individuals’ inherent desire to stay close to what they value most and the high-quality user experience that our platform provides. We have also cultivated an online Arlo Community, where users can share Arlo video content and give each other tips on using Arlo devices. In 2016 and 2017, the number of unique visitors to the Arlo Community website reached 1.0 million and 2.3 million, respectively.

We believe that the power of our platform increases as the number of users and devices on the platform grows. As our user base and community grow, more devices are connected to our platform, which enables us to analyze an increasing volume of data, and in turn facilitates more refined computer vision algorithms. We expect that these improving capabilities will enable us to offer more innovative and intelligent services and features to our users, who we believe will increasingly be willing to pay for subscription services to benefit from these

 

(1) 

Gartner, Forecast: Internet of Things—Endpoints and Associated Services, Worldwide, 2017, 21 December 2017, Table 4.1.

(2) 

Gartner, Forecast: Internet of Things—Endpoints and Associated Services, Worldwide, 2017, 21 December 2017, Table 4.1 (Home Automation/Other, Home Energy Management, Home Security and Safety) & 12.1 (Home Security and Safety, Home Automation, Energy Management, Other).

(3) 

The NPD Group, Inc., U.S. Retail Weekly Tracking Service, Security & Monitoring, Camera technology: excludes baby monitors, Security camera system type: excludes not remote viewing ready, Brand: NETGEAR (Arlo), based on dollar sales, April 8, 2018 - July 7, 2018.



 

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capabilities. We believe that, as awareness of our platform grows, more users will seek to purchase both our smart connected devices and our Arlo Smart services and join our rapidly growing user base.

We have built the Arlo platform on three key technology differentiators:

 

    Radio Frequency (“RF”) Connectivity and Power Management Expertise. Our leading RF connectivity expertise, developed through nearly 20 years of research and development, enables whole home coverage via Wi-Fi and in remote areas via cellular networks and industry-leading time-to-first-frame (“TTFF”) performance to minimize lag between motion detection and video recording. Our proven power management expertise, leveraged from NETGEAR’s years of experience building mobile hotspots, encompasses hardware product design, software and firmware, including patented beaconing and power management methods, to prolong battery life.

 

    Product Design. Our aesthetically appealing, compact and weather-resistant industrial design has won multiple awards and provides our users the freedom and flexibility to place our products both inside and outside the home without professional installation services.

 

    Broad Compatibility. We purposefully designed Arlo products to have broad compatibility, allowing them to be integrated with leading third-party IoT products and protocols.

These differentiators, in combination with our scalable cloud infrastructure and AI-enabled features delivered in real-time through the Arlo app, have positioned Arlo to be the smart platform of choice for many consumers and businesses.

As an operating segment of NETGEAR, we have benefitted from its decades of technological expertise, deep and long-standing relationships with suppliers and channel partners and established business processes and leadership teams. While our history with NETGEAR has provided us with certain competitive advantages, we believe that the separation, this offering and the distribution will provide a number of additional benefits to our business. See the section titled “—NETGEAR Ownership and Our Separation from NETGEAR.”

We have experienced significant growth since the launch of our first product in December 2014, and according to NPD Group, Arlo is the leader in the U.S. consumer network connected camera systems market. Outside of the United States, we are also the leader in Australia and several major European markets. In 2016, Arlo grew revenue by 108% over the prior year to $184.6 million, and in 2017, Arlo further grew revenue by 101% over the prior year to $370.7 million. For additional information regarding Arlo’s financial performance, see the section titled “Selected Combined Financial Data.”

Key Trends Driving Our Market

The intersection of the following significant technology trends are driving mass adoption of a new generation of smart IoT connected lifestyle platforms:

 

    The Proliferation of IoT Devices. According to Gartner, there were eight billion consumer IoT endpoint installed base units in 2017, and this number is expected to reach 25 billion by 2021.(4)

 

(4)  Gartner, Forecast Analysis: Internet of Things—Endpoints, Worldwide, 2017 Update, 27 December 2017, Table 1.


 

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Gartner expects that consumer IoT endpoint unit installed base spending will be the largest segment, encompassing 64% of the market in 2021.(5) We believe the new generation of smart IoT platforms, like Arlo, will feature smart devices that are always connected to the cloud, AI-based services and mobile apps through which users can manage their connected devices, creating a highly engaging user experience.

 

   

Adoption of Cloud-Based Connectivity and Infrastructure. According to Gartner, public cloud services spending is expected to reach $302 billion by 2021, growing at a CAGR of 19% from 2016 to 2021.(6) Scalable public cloud computing infrastructure has allowed companies to innovate at a rapid pace and pass along the benefits to end-users in the form of intelligent and real-time services delivered at low cost and low latency.

 

   

The Mobile Era. The universal adoption of smartphones and tablets has transformed the way people interact with each other and their environments. According to IDC, more than 1.6 billion smartphones and tablets were shipped in 2017. Having experienced this transformation, consumers are increasingly demanding a convenient and efficient mobile experience to drive today’s connected lifestyle.

 

   

Consumer Preference for a Do-It-Yourself (“DIY”) Experience. Among users of home IoT devices, ease of installation and ease of use are the most sought after attributes according to IDC.

 

   

Big Data Analytics and AI Adoption. According to IDC, the volume of information being processed and transferred globally is expected to reach 163ZB (trillion gigabytes) by 2025, a ten-fold increase compared to 2016. As more data is collected and processed, AI-enabled products and services are becoming more sophisticated and gaining mass adoption by consumers, leading to a smarter and more convenient lifestyle. According to IDC, widespread adoption of cognitive systems and AI across a broad range of industries will drive worldwide spending on AI and cognitive systems from nearly $12 billion in 2017 to $58 billion in 2021.

 

   

Safety and Security Are Top Use Cases in Connected Technology. According to Parks Associates, U.S. consumers view safety and security as one of the most important benefits of smart home systems. We believe the peace of mind arising from being connected is a powerful driver of consumer and small business purchasing behavior, promoting the rapid and continuing adoption of connected technology.

Our Competitive Advantages — What Sets Us Apart

 

   

Best-in-Class Technology. Our engineers continually push the boundaries of innovation to develop products that leverage our cutting-edge technological capabilities, including our RF connectivity expertise, power management expertise, sleek, weather-resistant product design, broad compatibility, cloud-based platform and AI.

 

   

Market Leadership in Consumer Network Connected Camera Systems. According to NPD, for the second quarter of 2018, we held 48% market share based on dollar sales in the U.S. consumer

 

(5) 

Gartner, Forecast Analysis: Internet of Things—Endpoints, Worldwide, 2017 Update, 27 December 2017, Table 2: 2021 consumer data point divided by 2021 total data point.

(6) 

Gartner, Forecast: Public Cloud Services, Worldwide, 2015-2021, 4Q17 Update, 15 January 2018, Table 1-1.



 

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network connected camera systems market.(7) Outside of the United States, we are also the leader in Australia and several major European markets.

 

    Direct Relationship with Users and User Engagement. According to Sensor Tower, for the first quarter of 2018, the Arlo app had a user engagement rate, measured by daily active users divided by monthly active users, of 37%. Unlike legacy consumer devices, we maintain an ongoing relationship with the end-user of our products through the Arlo app and the Arlo Community.

 

    Trusted Platform. We believe our platform is trusted by users because of our singular focus on enabling a connected lifestyle, without the need to sell any advertising services. We do not disclose user information to any third parties for marketing or promotional purposes, and all data collected is protected from public disclosure by various technological and procedural mechanisms. This commitment to user data privacy, along with strict company-wide information security policies and procedures, creates a foundation of trust that allows Arlo to become a key part of its end-users’ connected lives.

 

    The Arlo Brand and Channel Partners. Arlo’s strong brand recognition, along with its deep and long-standing channel partnerships established under NETGEAR, have enabled us to feature Arlo products prominently across our distribution channels. In addition, we have a significant share of shelf space with our channel partners, including U.S. retail and mobile operators.

Our Growth Strategy

We primarily generate revenue by selling devices through retail, wholesale distribution and wireless carrier channels and paid subscription services through in-app purchases. We believe that we can continue to charge a premium price over competing products because of our superior product features, ease of use and bundled prepaid services, such as rolling seven-day cloud video storage. We further enhance the user experience by offering our subscription-based Arlo Smart services, which include features such as actionable intelligence, rich app notifications and extended data storage. Since the launch of the original Arlo Security Camera in December 2014, we have introduced six additional Arlo devices, and we plan to continue to launch new camera and non-camera products and services to the Arlo ecosystem and grow our number of registered users and subscribers.

Our goal is to continue to develop innovative, world-class connected lifestyle solutions to expand and further monetize our current and future user and subscriber bases.

The key elements of our growth strategy to achieve this goal are:

 

    Continue to Innovate and Grow Our Installed Base. We have brought numerous leading and innovative new products to market, such as our wire-free, weather-resistant internet protocol (“IP”) cameras, lights and the first commercially available LTE-enabled camera. We plan to expand the Arlo ecosystem and grow our installed base by continuing to innovate on our current product lines and by expanding into adjacent categories.

 

    Increase Subscription-Based Recurring Revenue. We sell our paid subscription services to our fast-growing user base, enabling us to generate recurring revenue streams. As our AI capabilities further mature through machine learning, we plan to introduce compelling new subscription-based features to further grow and monetize our user base.

 

(7)  The NPD Group, Inc., U.S. Retail Weekly Tracking Service, Security & Monitoring, Camera technology: excludes baby monitors, Security camera system type: excludes not remote viewing ready, Brand: NETGEAR (Arlo), based on dollar sales, April 8, 2018 - July 7, 2018.


 

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    Invest in Brand and Channel. We plan to grow brand awareness through direct and indirect marketing and form a lasting relationship with our end-users throughout their journey from product discovery through the entire lifecycle of ownership.

 

    Continue Global Expansion. Although a majority of our focus has been on the U.S. market, the growth in connected lifestyle is a global trend. Our goal is to replicate our U.S. success across international markets.

Our Solutions

We offer our solutions through the Arlo platform. The backbone of the Arlo platform is our scalable and intelligent cloud computing engine, which continuously processes the data collected from Arlo devices and, in turn, provides actionable intelligence in the form of real-time notifications to our users through the Arlo app. We designed our platform to meet a wide range of user needs with its depth of features, AI-enabled services and support for our growing number of smart connected devices. In addition, the Arlo platform is built with broad compatibility and integrates with leading third-party IoT products and protocols, allowing our users to customize and personalize their own connected lifestyle experience.

Benefits of Our Solutions

Our products and solutions offer a unique set of capabilities that address a growing market opportunity, which has resulted in rapid user adoption and has enabled Arlo to become the current leader in the U.S. consumer network connected camera systems market. Our products and solutions offer the following benefits:

 

    Versatility. Our existing devices are wireless, wire-free, battery-operated and weather-resistant for ease of outdoor use and placement in hard-to-access areas.

 

    Performance. Our hardware, software and back-end cloud infrastructure work together seamlessly to offer high-quality video with low latency, which in turn enables real-time monitoring and only 250 milliseconds lag between motion detection and video recording.

 

    Convenience. We design our devices for simplicity, ease of use and a convenient DIY out-of-box experience. Through the Arlo app, users are able to interact with all of their Arlo devices through a single user interface and customize video, audio and power management settings based on their preferences.

 

    Intelligence. Our smart platform evolves as we continue to leverage our data analytics and machine learning capabilities, which allow for richer platform functionality. Computer vision enables our devices to distinguish between people and other less meaningful motion events such as cars driving by or trees swaying in the wind, thereby reducing false alerts and increasing the utility and efficiency of the Arlo platform.

 

    Interoperability. The Arlo platform is built with broad compatibility, integrating with leading third-party IoT products and protocols, providing additional opportunities for us to acquire users.

Our Products

Smart Connected Devices

 

    Arlo Security Camera, released in the fourth quarter of 2014, is the world’s first commercially available 100% battery-operated Wi-Fi security camera with 720p HD video quality, IP65-rated weather resistance and night vision.


 

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    Arlo Q and Arlo Q Plus, released in the fourth quarter of 2015, bring Arlo’s performance and design to an indoor wired solution that allows users to easily monitor their surroundings with 1080p HD video quality.

 

    Arlo Pro, released in the fourth quarter of 2016, is our second generation battery-operated, IP65-rated weather-resistant Wi-Fi camera, which adds key new features and significant camera upgrades, including two-way audio and rechargeable batteries.

 

    Arlo Go, released in the first quarter of 2017, is the world’s first commercially available LTE-enabled wire-free camera and provides untethered mobile monitoring supported by major networks in key markets around the world.

 

    Arlo Baby, released in the second quarter of 2017, combines performance and convenience with smart features, such as air quality and temperature sensors, motion and audio detection, and advanced night vision, that provide added peace of mind for parents and caregivers.

 

    Arlo Pro 2, released in the fourth quarter of 2017, is the latest generation of our battery-operated, IP65-rated weather-resistant Wi-Fi cameras and includes advancements in sound and motion detection.

 

    Arlo Security Light, released in the second quarter of 2018, delivers powerful, wire-free lighting that works intelligently both by itself or when paired with Arlo’s cameras.

 

    Arlo Audio Doorbell and Arlo Chime, the latest additions to join the growing Arlo ecosystem later this year, are engineered to work as a standalone smart audio doorbell solution or to pair with any Arlo camera or Arlo Security Light for a more complete view of the entryway.

 

    Our Accessories are designed to complement our smart connected devices and provide additional convenience, versatility and customization for our users, and include our charging accessories, device mounts and device skins.

The Arlo App

The Arlo app, available for iOS and Android devices, is designed to provide our users with an easy-to-use, flexible, mobile-first experience that connects our users to the people and things that matter most to them.

Arlo Services

Our prepaid service, included with the sale of our cameras, provides users with rolling seven-day cloud video storage, the ability to connect up to five cameras and 90 days of customer support.

Launched in 2018, Arlo Smart is a paid subscription service that adds powerful AI capabilities to our cameras that enhance the user experience. Through real-time computer vision algorithms, Arlo Smart provides users a more personalized experience, deeper insights into detected activity and streamlined access to take responsive actions in urgent situations, such as contacting local emergency services. Some of Arlo Smart’s key features include person detection, e911 emergency call service, cloud activity zones and rich app notifications.

NETGEAR Ownership and Our Separation from NETGEAR

Currently, and at all times prior to the completion of this offering, we are and will be an operating segment of NETGEAR. Upon the completion of this offering, we expect that NETGEAR will own approximately



 

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86.0% of our outstanding common stock (or approximately 84.2% if the underwriters exercise their option to purchase additional shares in full).

Prior to the completion of this offering, we will enter into agreements with NETGEAR that will govern the separation of our business from NETGEAR and various interim arrangements. These agreements will be in effect as of the completion of this offering. They will provide for, among other things, the transfer from NETGEAR to us of assets and the assumption by us of liabilities comprising our business through a separation agreement between us and NETGEAR (the “master separation agreement”). For more information regarding the assets and liabilities to be transferred to us, see our unaudited pro forma condensed combined financial statements and the related notes included elsewhere in this prospectus.

We also expect to enter into certain other agreements that will provide a framework for our relationship with NETGEAR after the separation, including:

 

    a transition services agreement governing NETGEAR’s provision of various services to us, and our provision of various services to NETGEAR, on a transitional basis (the “transition services agreement”);

 

    a tax matters agreement with NETGEAR that will govern the respective rights, responsibilities and obligations of NETGEAR and us after the closing of this offering with respect to tax matters (including responsibility for taxes attributable to us and our subsidiaries, entitlement to refunds, allocation of tax attributes, preparation of tax returns, control of tax contests and other matters) (the “tax matters agreement”);

 

    an employee matters agreement with NETGEAR that will address employment, compensation and benefits matters, including the allocation and treatment of assets and liabilities relating to employees and compensation and benefit plans and programs in which our employees participate prior to the distribution, as well as other human resources, employment and employee benefit matters (the “employee matters agreement”);

 

    an intellectual property rights cross-license agreement with NETGEAR, which will govern our and NETGEAR’s rights, responsibilities and obligations to use NETGEAR and Arlo intellectual property, respectively (the “intellectual property rights cross-license agreement”); and

 

    a registration rights agreement with NETGEAR, pursuant to which we will grant NETGEAR and its affiliates certain registration rights with respect to our common stock owned by them (the “registration rights agreement”).

In this prospectus, references to the “contribution” refer to NETGEAR’s transfer to us (in connection with certain reorganization transactions) of the assets and liabilities related to our business, and the term “separation” refers to the separation of our business from NETGEAR’s other businesses (including the contribution), along with the effectiveness of various agreements between us and NETGEAR.

See the section titled “Certain Relationships and Related Party Transactions—Relationship with NETGEAR” for a more detailed discussion of these agreements. All of the agreements relating to our separation from NETGEAR will be made in the context of a parent-subsidiary relationship and will be entered into in the overall context of our separation from NETGEAR. The terms of these agreements may be more or less favorable to us than if they had been negotiated with unaffiliated third parties. See the section titled “Risk Factors—Risks Related to Our Separation from NETGEAR.”



 

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NETGEAR has informed us that, at some time in the future, but no earlier than the expiration or earlier termination of the 145-day lock-up period applicable to NETGEAR described under the section titled “Underwriting,” it intends to effect a distribution of its remaining ownership interest in us to its stockholders in a transaction that is generally expected to be tax-free for U.S. federal income tax purposes (the “distribution”). Under current tax law, NETGEAR must retain beneficial ownership of at least 80% of our combined voting power and 80% of each class of nonvoting capital stock, if any is outstanding, until immediately prior to such distribution in order to so qualify. To preserve the tax-free treatment of the separation and distribution, the master separation agreement will include certain covenants and restrictions to ensure that, until immediately prior to the distribution, NETGEAR will retain beneficial ownership of at least 80% of our combined voting power and 80% of each class of nonvoting capital stock, if any is outstanding. NETGEAR has no obligation to effect the distribution, and it may retain its ownership interest in us indefinitely or dispose of all or a portion of its ownership interest in us in a sale or other transaction. Any such distribution or other disposition by NETGEAR of its remaining interest in us (each, an “other disposition”) would be subject to market, tax and legal considerations, final approval by the NETGEAR board of directors and other customary requirements.

Under current law, the distribution could be rendered taxable to NETGEAR and its shareholders as a result of certain post-distribution acquisitions of our shares or assets. For example, the distribution may result in taxable gain to NETGEAR under Section 355(e) of the Internal Revenue Code of 1986, as amended (the “Code”), if the distribution were later deemed to be part of a plan (or series of related transactions) pursuant to which one or more persons acquire, directly or indirectly, shares representing a 50% or greater interest (by vote or value) in us. To preserve the tax-free treatment of the separation and distribution, we will agree in the tax matters agreement that we and our subsidiaries will be subject to certain restrictions during the two-year period following the distribution that are intended to prevent the distribution, together with certain related transactions, from failing to qualify as a transaction that is generally tax-free for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) of the Code. Specifically, during such period, except in specific circumstances or unless NETGEAR waives our obligation to comply with such restrictions, we expect that we and our subsidiaries will generally be prohibited from: (i) ceasing to conduct certain businesses, (ii) entering into certain transactions or series of transactions pursuant to which all or a portion of our common stock would be acquired or all or a portion of certain of our and our subsidiaries’ assets would be acquired, (iii) liquidating, merging or consolidating with any other person, (iv) issuing equity securities beyond certain thresholds, (v) repurchasing our stock other than in certain open-market transactions or (vi) taking or failing to take any other action that would cause the distribution, together with certain related transactions, to fail to qualify as a transaction that is generally tax-free for U.S. federal income tax purposes under Section 355 and 368(a)(1)(D) of the Code. These restrictions may limit our ability to pursue certain equity issuances, strategic transactions or other transactions that may maximize the value of our business. See the section titled “Certain Relationships and Related Party Transactions—Tax Matters Agreement.”

NETGEAR has no obligation to pursue or consummate any further disposition of its ownership interest in us by any specified date or at all.

We believe, and NETGEAR has advised us that it believes, that the separation, this offering and the distribution will provide a number of benefits to our business and to NETGEAR’s business. These intended benefits include improving the strategic and operational flexibility of both companies, increasing the focus of the management teams on their respective business operations and allowing each company to adopt the capital structure, investment policy and dividend policy best suited to its financial profile and business needs, and providing each company with its own equity currency to facilitate acquisitions and to better incentivize management. In addition, as we will be a stand-alone company, potential investors will be able to invest directly in our business.



 

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Risks Affecting Our Business

There are a number of risks that you should understand before making an investment decision regarding this offering. You should carefully consider the risks described in the section titled “Risk Factors” before making a decision to invest in our common stock. If any of these risks actually occur, our business, financial condition and results of operations would likely be negatively affected. In such case, the trading price of our common stock would likely decline, and you may lose part or all of your investment. These risks include, but are not limited to:

 

    fluctuations in our results of operations and stock price over time;

 

    our ability to introduce or acquire new products or services that achieve broad market acceptance;

 

    the potential for loss or disruption to our business and brand as a result of system security risks, data protection breaches or cyber-attacks;

 

    interruptions with the cloud-based systems that we use in our operations, which are provided by an affiliate of Amazon.com, Inc., one of our primary competitors;

 

    our ability to compete with our peers, certain of which have substantially greater resources than we do;

 

    the concentration of our customer base in traditional and online retailers and wholesale distributors, our ability to retain such retailers and distributors and our potential exposure in the event of the consolidation of retailers or concentration of retail market share;

 

    potential quality problems, including defects or errors, with our current and future products and services;

 

    the typical decrease of the average selling prices of our products over the sales cycle of the product, which may impact our revenue and gross margin;

 

    the effects of government laws and regulations regarding privacy and data protection;

 

    global economic conditions;

 

    changes in U.S. and international tax policy, including changes that adversely affect customs, tax or duty rates (such as the proposed higher tariffs on products imported from China recently announced by the Trump administration), as well as income tax legislation and regulations that affect the countries where we conduct business;

 

    the volatility of our stock price, which may result in your investment in our common stock to suffer a decline in value;

 

    our ability to manage our manufacturing and supply requirements and the ability of our manufacturing and supply sources to meet the needs of our business;

 

    our reliance on a limited number of third-party manufacturers;

 

    our ability to retain the services of key personnel;

 

    our ability to secure and protect our intellectual property rights;


 

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    our reliance on third parties for technology that is critical to our products, and our continued use and access to such technology;

 

    our exposure to international markets;

 

    the development and any future expansion of our operations and infrastructure;

 

    governmental regulations of imports or exports affecting internet security;

 

    current and future litigation matters, including litigation regarding intellectual property rights;

 

    our ability to manage our sales channel inventory and product mix;

 

    failure to achieve the expected benefits from and successfully execute the separation;

 

    potential tax liabilities that may arise as a result of the separation or the distribution;

 

    operating as an independent publicly traded company, including compliance with applicable laws and regulations;

 

    our status as an emerging growth company;

 

    our status as a controlled company, and the possibility that NETGEAR’s interests may conflict with our interests and the interests of our other stockholders; and

 

    the effects of future sales, or perceptions of future sales of our common stock and future equity grants.

Company Information

We were incorporated in Delaware in January 2018 in connection with our planned separation from NETGEAR. Our principal executive offices are at 350 East Plumeria Drive, San Jose, California 95134, and our telephone number is (408) 890-3900. Our website is www.arlo.com. The information and other content contained in, or accessible through, our website are not part of, and is not incorporated into, this prospectus, and investors should not rely on any such information in deciding whether to invest in our common stock.

JOBS Act

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). We will remain an emerging growth company until the earlier of (1) the last day of the fiscal year (a) following the fifth anniversary of the completion of this offering, (b) in which we have total annual revenue of at least $1.07 billion or (c) in which we become a large accelerated filer, which means that we have been public for at least 12 months, have filed at least one annual report and the market value of our common stock that is held by non-affiliates exceeds $700 million as of the last day of our then most recently completed second fiscal quarter, and (2) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period. In addition, the JOBS Act provides that an emerging growth company can delay adopting new or revised accounting standards until such time as those standards apply to private companies. While we have not made such an irrevocable election, we have not delayed the adoption of any applicable accounting standards.



 

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Recent Developments

Preliminary Results for the Three Months Ended July 1, 2018

Preliminary results for the three months ended July 1, 2018 are expected to be as follows:

For the three months ended July 1, 2018, we expect to report revenue in the range of $107.0 million to $112.0 million compared to $100.6 million for the three months ended April 1, 2018 and $79.2 million for the three months ended July 2, 2017.

For the three months ended July 1, 2018, we expect to report gross margin in the range of 25.0% to 26.0% compared to 28.9% for the three months ended April 1, 2018 and 21.1% for the three months ended July 2, 2017.

The estimated ranges for the three months ended July 1, 2018 are preliminary and may change. We have yet to complete our normal quarterly review procedures for the three months ended July 1, 2018, and as such, there can be no assurance that our final results for this period will not differ from these estimates. Any such changes could be material. These estimates should not be viewed as a substitute for full interim financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). In addition, these preliminary results of operations for the three months ended July 1, 2018, are not necessarily indicative of the results to be achieved for the remainder of 2018 or any future period.

As of July 1, 2018, we have shipped 8.6 million smart connected devices, and, as of July 1, 2018, our smart platform had over 2.2 million registered users across more than 100 countries around the world. For June 2018, Arlo users collectively streamed an average of over 67 million videos daily. According to NPD, for the second quarter of 2018, we held 48% market share based on dollar sales in the U.S. consumer network connected camera systems market.(8)

Arlo Audio Doorbell and Arlo Chime

On July 23, 2018, NETGEAR announced the introduction of the Arlo Audio Doorbell and Arlo Chime. See the section titled “BusinessOur Products.

 

 

(8)  The NPD Group, Inc., U.S. Retail Weekly Tracking Service, Security & Monitoring, Camera technology: excludes baby monitors, Security camera system type: excludes not remote viewing ready, Brand: NETGEAR (Arlo), based on dollar sales, April 8, 2018 - July 7, 2018.


 

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The Offering

 

Issuer

Arlo Technologies, Inc.

 

Common stock offered by us in this offering

10,215,000 shares (11,747,250 shares if the underwriters exercise their option to purchase additional shares in full).

 

Common stock to be held by NETGEAR immediately after this offering

62,500,000 shares.

 

Common stock to be outstanding immediately after this offering

72,715,000 shares (74,247,250 shares if the underwriters exercise their option to purchase additional shares in full).

 

Underwriters’ option

We have granted the underwriters an option for a period of 30 days after the date of this prospectus to purchase up to 1,532,250 additional shares of common stock.

 

Use of proceeds

We estimate that the net proceeds from this offering, after deducting the underwriting discount and estimated offering expenses payable by us, will be approximately $173.1 million (or approximately $200.1 million if the underwriters’ option to purchase additional shares is exercised in full), assuming that the shares of our common stock to be sold in this offering are sold at $19.00 per share, the midpoint of the price range set forth on the cover page of this prospectus. We intend to use the net proceeds of this offering for general corporate purposes. See the section titled “Use of Proceeds.”

 

Risk factors

You should read the “Risk Factors” section of this prospectus for a discussion of factors to consider carefully before deciding to invest in shares of our common stock.

 

Stock exchange symbol

We have applied for listing of our common stock on the NYSE under the symbol “ARLO.”

 

Reserved share program

At our request, the underwriters have reserved for sale, at the initial public offering price, up to 5% of the shares offered by this prospectus for sale to some of our directors, officers, employees, business associates and other persons designated by us. See the section titled “Underwriting.”

Unless otherwise indicated, all references to the number and percentage of shares of common stock outstanding and percentage ownership information are based on our “pro forma shares of common stock,” in each case following this offering and the separation and assuming the following:

 

    there is no exercise of the underwriters’ option to purchase up to 1,532,250 additional shares of our common stock; and


 

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the number of pro forma shares of common stock excludes the shares of our common stock reserved for issuance under benefit plans for our employees and directors (9 million shares of our common stock, plus the number of shares of our common stock that may be issuable upon exercise or vesting of awards relating to NETGEAR common stock that may be converted into awards relating to our common stock upon the completion of the distribution).

Unless otherwise indicated, the information presented in this prospectus:

 

   

gives effect to the separation as described under “Certain Relationships and Related Party Transactions—Relationship with NETGEAR”;

 

   

assumes that the shares of our common stock to be sold in this offering are sold at $19.00 per share, the midpoint of the price range set forth on the cover page of this prospectus; and

 

   

assumes the underwriters will not exercise their option to purchase additional shares.



 

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Summary Historical and Pro Forma Condensed Combined Financial Data

The following financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our annual audited combined financial statements, the unaudited interim combined financial statements and the related notes, and our unaudited pro forma condensed combined financial statements and the related notes, included elsewhere in this prospectus.

The following table summarizes our historical and pro forma combined financial data. The summary historical combined balance sheet data as of December 31, 2017 and 2016 and statements of operations data for the years ended December 31, 2017 and 2016 are derived from our audited combined financial statements included elsewhere in this prospectus. The summary historical combined balance sheet data as of April 1, 2018 and statements of operations data for the three months ended April 1, 2018 and April 2, 2017 are derived from our unaudited interim combined financial statements included elsewhere in this prospectus. We have prepared the unaudited interim combined financial statements on the same basis as the audited combined financial statements and have included all adjustments, consisting only of normal recurring adjustments that, in our opinion, are necessary to state fairly the financial information set forth in those statements. Our historical results are not necessarily indicative of our results in any future period. To ensure a full understanding of the summary financial data, the information presented below should be reviewed in combination with the audited and unaudited interim combined financial statements and the related notes thereto included elsewhere in this prospectus.

Our historical combined financial statements, which are discussed below, are prepared on a stand-alone basis in accordance with U.S. generally accepted accounting principles (“GAAP”) and are derived from NETGEAR’s consolidated financial statements and accounting records using the historical results of operations and assets and liabilities attributed to our operations, and include allocations of expenses from NETGEAR. Our combined results are not necessarily indicative of our future performance and do not reflect what our financial performance would have been had we been a stand-alone public company during the periods presented.

NETGEAR currently provides certain services to us, and costs associated with these functions have been allocated to us. The allocations include costs related to corporate services, such as executive management, information technology, legal, finance and accounting, human resources, tax, treasury, research and development, sales and marketing, shared facilities and other services. These costs were allocated on a basis of revenue, headcount or other measures we have determined as reasonable. Stock-based compensation includes expense attributable to our employees and an allocation of stock-based compensation attributable to employees of NETGEAR. These allocations are primarily reflected within operating expenses in our combined statements of operations. Management believes the basis on which the expenses have been allocated to be a reasonable reflection of the utilization of services provided to, or the benefit received by, us during the periods presented. However, these allocations may not necessarily be indicative of the actual expenses we would have incurred as an independent company during the periods prior to the offering or of the costs we will incur in the future.

Following the completion of this offering, we expect NETGEAR to continue to provide certain of the services described above on a transitional basis for a fee. These services will be provided under the transition services agreement described in “Certain Relationships and Related Party Transactions—Relationship with NETGEAR—Arrangements Between NETGEAR and Our Company.” We generally expect to use the vast majority of these services for less than a year following the completion of this offering, depending on the type of the service and the location at which such service is provided. However, we may agree with NETGEAR to extend the service periods for a limited amount of time (which period will not extend past the first anniversary of the distribution) or may terminate such service periods by providing prior written notice. The unaudited pro forma condensed combined financial statements have not been adjusted for the effects of these transition services as we believe the allocation for such services, as previously described, is fairly reflected within the results presented.



 

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Following the completion of this offering, we will be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We will be required to establish procedures and practices as a stand-alone public company in order to comply with our obligations under the Exchange Act and related rules and regulations. As a result, we will incur additional costs, including internal audit, investor relations, stock administration and regulatory compliance costs. These additional costs may differ from the costs that were historically allocated to us from NETGEAR. To operate as a stand-alone company, we expect to incur costs to replace certain services previously provided by NETGEAR, which may be higher than those reflected in our historical combined financial statements. A component of these costs are IT-related costs, including capital expenditures, to implement certain new systems, including infrastructure and an enterprise resource planning system, while our legacy systems are being fully supported by NETGEAR, which we estimate to be $35.0 million to $55.0 million in the next 12 months. Actual costs that may have been incurred had we been a stand-alone company depend on a number of factors, including organizational structure and decisions made relating to various areas such as information technology and infrastructure.

The summary unaudited pro forma condensed combined financial data reflects the impact of certain transactions, which comprise the following:

 

   

the separation, as described in the section titled “Certain Relationships and Related Party Transactions—Relationship with NETGEAR”; and

 

   

the receipt of approximately $173.1 million in net proceeds from the sale of shares of our common stock in this offering at an assumed initial offering price of $19.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, after deducting the underwriting discount and estimated offering expenses payable by us.

The unaudited pro forma condensed combined balance sheet data reflects the above transactions as if they had occurred on April 1, 2018, while the unaudited pro forma condensed combined statements of operations data gives effect to the above adjustments as if they occurred on January 1, 2017. The pro forma adjustments, described in the section titled “Unaudited Pro Forma Condensed Combined Financial Statements,” are based on currently available information and certain assumptions that management believes are reasonable.

The unaudited pro forma condensed combined financial data is provided for illustrative purposes only and is not necessarily indicative of the operating results or financial position that would have occurred had the separation from NETGEAR or this offering been completed on April 1, 2018 for the unaudited pro forma condensed combined balance sheet data or on January 1, 2017 for the unaudited pro forma condensed combined statements of operations data. The unaudited pro forma condensed combined financial data should not be relied on as indicative of the historical operating results that we would have achieved or any future operating results or financial position that we will achieve after the completion of this offering.



 

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     Pro Forma
as Adjusted
    Historical  
     Three Months
Ended
    Year Ended
December 31,
    Three Months
Ended
    Year Ended
December 31,
 
    

April 1, 2018

   

        2017         

   

April 1, 2018

   

April 2, 2017

   

        2017         

    

        2016         

 
     (In thousands, except per share data)  

Combined Statements of Operations Data:

             

Revenue

   $ 100,638     $ 370,658     $ 100,638     $ 61,803     $ 370,658      $ 184,604  

Cost of revenue

     71,585       279,424       71,585       45,450       279,424        146,570  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Gross profit

     29,053       91,234       29,053       16,353       91,234        38,034  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Operating expenses:

             

Research and development

     12,247       35,972       12,025       7,984       34,683        24,438  

Sales and marketing

     11,212       34,340       11,212       5,721       34,340        18,455  

General and administrative

     6,331       23,322       4,878       2,745       15,096        8,289  

Separation expense

     —         —         6,557       —         1,384        —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total operating expenses

     29,790       93,634       34,672       16,450       85,503        51,182  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Income (loss) from operations

     (737     (2,400     (5,619     (97     5,731        (13,148

Other income (expense), net

     575       1,946       575       340       1,946        (512
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Income (loss) before income taxes

     (162     (454     (5,044     243       7,677        (13,660

Provision for income taxes

     319       1,516       319       219       1,128        83  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ (481   $ (1,970   $ (5,363   $ 24     $ 6,549      $ (13,743
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Pro forma net loss per share:

             

Basic

     (0.01 )(a)      (0.03 )(a)      N/A       N/A       N/A        N/A  

Diluted

     (0.01 )(a)      (0.03 )(a)      N/A       N/A       N/A        N/A  

Pro forma weighted-average shares used to compute net loss per share:

             

Basic

     72,715 (a)      72,715 (a)      N/A       N/A       N/A        N/A  

Diluted

     72,715 (a)      72,715 (a)      N/A       N/A       N/A        N/A  

 

(a) The weighted-average number of shares used to compute pro forma basic and diluted net loss per share represents the number of shares of our common stock outstanding immediately following the completion of this offering.


 

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Pro Forma
as Adjusted

     Historical  
    

As of

April 1,

    

As of

April 1,

    

As of December 31,

 
    

2018

    

2018

    

2017

    

2016

 
     (In thousands)  

Combined Balance Sheet Data:

           

Cash and cash equivalents*

   $ 243,247      $ 178      $ 108      $ 220  

Working capital

   $ 274,210      $ 81,901      $ 112,878      $ 54,967  

Total assets

   $ 375,223      $ 235,751      $ 269,820      $ 158,581  

Deferred revenue, current and non-current

   $ 40,420      $ 40,420      $ 47,404      $ 23,393  

Total liabilities

   $ 91,099      $ 142,814      $ 144,401      $ 85,407  

Total equity

   $ 284,124      $ 92,937      $ 125,419      $ 73,174  

 

*

The pro forma as adjusted cash and cash equivalents of $243.2 million as of April 1, 2018 reflects the following adjustments (a) the receipt of approximately $173.1 million by us associated with the sale of shares of common stock in this offering at the initial public offering price of $19.00 per share (the midpoint of the price range set forth on the cover page of this prospectus) after deducting the underwriting discount and estimated offering expense payable by us, and (b) $70.0 million of cash that NETGEAR intends to contribute to us in the period leading up to the separation, a portion of which we may use prior to the separation for operating expenses, working capital and other requirements. See the sections titled “Notes to Unaudited Pro Forma Condensed Combined Financial Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources.”



 

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TRADEMARKS, TRADE NAMES AND SERVICE MARKS

We use various trademarks, trade names and service marks in our business, including Arlo, Arlo Pro, Arlo Q, Arlo Baby and Arlo Smart. For convenience, we may not include the SM, ® or ™ symbols, but such omission is not meant to indicate that we would not protect our intellectual property rights to the fullest extent allowed by law. Any other trademarks, trade names or service marks referred to in this prospectus are the property of their respective owners.

INDUSTRY AND MARKET DATA

This prospectus includes industry data and forecasts that we obtained from industry publications and surveys, public filings and internal company sources. Industry publications, surveys and forecasts generally state that the information contained therein has been obtained from sources believed to be reliable, but there can be no assurance as to the accuracy or completeness of the included information. Statements as to our ranking, market position and market estimates are based on independent industry publications, third-party forecasts, management’s estimates and assumptions about our markets and our internal research. We have not independently verified third-party information nor have we ascertained the underlying economic assumptions relied upon in such sources, and we cannot assure you of the accuracy or completeness of such information contained in this prospectus. Such data involves risks and uncertainties and is subject to change based on various factors, including those discussed under the sections titled “Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements.”

The Gartner Reports described herein represent research opinion or viewpoints published, as part of a syndicated subscription service, by Gartner, Inc. and are not representations of fact. Each Gartner Report speaks as of its original publication date (and not as of the date of this Prospectus) and the opinions expressed in the Gartner Reports are subject to change without notice.

Certain information in the text of this prospectus is contained in industry publications or data provided by third parties. The sources of these industry publications and data are provided below:

 

    Gartner: Forecast Analysis: Internet of Things—Endpoints, Worldwide, 2017 Update, published December 2017

 

    Gartner: Forecast: Internet of Things—Endpoints and Associated Services, Worldwide, 2017, published December 2017

 

    Gartner: Forecast: Public Cloud Services, Worldwide, 2015–2021, 4Q17 Update, published January 2018

 

    International Data Corporation: 2017 Consumer Internet of Things Survey: Home Automation, Monitoring and Control, published March 2017

 

    International Data Corporation: Worldwide Semiannual Cognitive Artificial Intelligence Systems Spending Guide, published March 2018

 

    International Data Corporation: Worldwide Smartphone Forecast, 2018–2022, published March 2018

 

    International Data Corporation: Worldwide Storage for Big Data and Analytics Forecast, 2017–2021, published September 2017

 

    International Data Corporation: Worldwide Tablet Forecast, 2018–2022, published March 2018

 

    The NPD Group, Inc., U.S. Retail Tracking Service, Security & Monitoring, Camera technology: excludes baby monitors, Security camera system type: excludes not remote viewing ready, based on dollars, Dec. 2015

 

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    The NPD Group, Inc., U.S. Retail Weekly Tracking Service, Security & Monitoring, Camera technology: excludes baby monitors, Security camera system type: excludes not remote viewing ready, Brand: NETGEAR (Arlo), based on dollar sales, April 8, 2018 - July 7, 2018

 

    Parks Associates: American Broadband Households and Their Technologies, published Q4 2016

 

    Parks Associates: 360 View: Smart Home Buyer Journey and User Experience, published Q2 2018

 

    Sensor Tower: Average daily active users and monthly active users on iOS platform in U.S. for the first quarter of 2018

 

    Tractica: Computer Vision Technologies and Markets Software, Hardware, and Services to Enable 28 Use Cases for Video Surveillance, Automotive, Medical, Localization and Mapping, and Other Applications: Global Market Analysis and Forecasts, published Q1 2018

 

    United States Small Business Administration: United States Small Business Profile, 2016 – SBA Office of Advocacy, published March 2016

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This prospectus includes forward-looking statements that involve substantial risks and uncertainties. All statements other than statements of historical facts contained in this prospectus, including statements regarding our industry, position, goals, strategy, future operations, future financial position, business strategy and plans, future revenues, estimated costs, prospects, margins, profitability, capital expenditures, liquidity, capital resources, plans and objectives of management, including those made in the sections titled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” are forward-looking statements. The words “anticipate,” “believe,” “estimate,” “likely,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “forecast,” “target,” “potential,” “will,” “would,” “could,” “should,” “continue,” “contemplate,” “might,” “objective,” “ongoing,” “seek” and similar expressions, as they relate to us, are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs, including current expectations and assumptions regarding, as of the date such statements are made, our future operating performance and financial condition, including our separation from NETGEAR, the expected timetable for the separation and the distribution and our future financial and operating performance, strategic and competitive advantages, leadership and future opportunities, as well as the economy and other future events or circumstances. Our expectations and assumptions include, without limitation, internal forecasts and analyses of current and future market conditions and trends, management plans and strategies, operating efficiencies and economic conditions, and risks and uncertainties described in the section titled “Risk Factors” and elsewhere in this prospectus. These risks and uncertainties include, without limitation:

 

    fluctuations in our results of operations and stock price over time;

 

    our ability to introduce or acquire new products or services that achieve broad market acceptance;

 

    the potential for loss or disruption to our business and brand as a result of system security risks, data protection breaches or cyber-attacks;

 

    interruptions with the cloud-based systems that we use in our operations, which are provided by an affiliate of Amazon.com, Inc., one of our primary competitors;

 

    our ability to compete with our peers, certain of which have substantially greater resources than we do;

 

    the concentration of our purchaser base in traditional and online retailers and wholesale distributors, our ability to retain such retailers and distributors and our potential exposure in the event of the consolidation of retailers or concentration of retail market share;

 

    potential quality problems, including defects or errors, with our current and future products and services;

 

    the typical decrease of the average selling prices of our products over the sales cycle of the product, which may impact our revenue and gross margin;

 

    the effects of government laws and regulations regarding privacy and data protection;

 

    global economic conditions;

 

    changes in U.S. and international tax policy, including changes that adversely affect customs, tax or duty rates (such as the proposed higher tariffs on products imported from China recently announced by the Trump administration), as well as income tax legislation and regulations that affect the countries where we conduct business;

 

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    the volatility of our stock price, which may result in your investment in our common stock to suffer a decline in value;

 

    our ability to manage our manufacturing and supply requirements and the ability of our manufacturing and supply sources to meet the needs of our business;

 

    our reliance on a limited number of third-party manufacturers;

 

    our ability to retain the services of key personnel;

 

    our ability to secure and protect our intellectual property rights;

 

    our reliance on third parties for technology that is critical to our products, and our continued use and access to such technology;

 

    our exposure to international markets;

 

    the development and any future expansion of our operations and infrastructure;

 

    governmental regulations of imports or exports affecting internet security;

 

    current and future litigation matters, including litigation regarding intellectual property rights;

 

    our ability to manage our sales channel inventory and product mix;

 

    failure to achieve the expected benefits from and successfully execute the separation;

 

    potential tax liabilities that may arise as a result of the separation or the distribution;

 

    operating as an independent publicly traded company, including compliance with applicable laws and regulations;

 

    our status as an emerging growth company;

 

    our status as a controlled company, and the possibility that NETGEAR’s interests may conflict with our interests and the interests of our other stockholders; and

 

    the effects of future sales, or perceptions of future sales of our common stock and future equity grants.

In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this prospectus may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements. We believe the factors identified above are important factors, but not necessarily all of the important factors, that could cause actual results to differ materially from those expressed in any forward-looking statement made by us.

You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. In addition, neither we nor any other person assumes responsibility for the accuracy and completeness of any of these forward-looking statements. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any

 

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specified time frame, or at all. These forward-looking statements speak only as of the date of this prospectus. Except as required by law, we assume no obligation to update or revise these forward-looking statements for any reason, even if new information becomes available in the future.

See the section titled “Risk Factors” for a more complete discussion of the risks and uncertainties mentioned above and for discussion of other risks and uncertainties. All forward-looking statements attributable to us are expressly qualified in their entirety by these cautionary statements as well as others made in this prospectus and hereafter in our other filings with the U.S. Securities and Exchange Commission (the “SEC”) and public communications. You should evaluate all forward-looking statements made by us in the context of these risks and uncertainties.

 

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RISK FACTORS

Investing in our common stock involves substantial risk. You should consider carefully the risks and uncertainties described below, together with all of the other information in this prospectus, including our financial statements and the related notes included elsewhere in this prospectus, before deciding whether to invest in shares of our common stock. We describe below what we believe are currently the material risks and uncertainties we face, but they are not the only risks and uncertainties we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occur, our business, financial condition, results of operations and future prospects could be materially and adversely affected. In that event, the market price of our common stock could decline and you could lose part or all of your investment.

Risks Related to Our Business

We expect our results of operations to fluctuate on a quarterly and annual basis, which could cause our stock price to fluctuate or decline.

Our results of operations are difficult to predict and may fluctuate substantially from quarter-to-quarter or year-to-year for a variety of reasons, many of which are beyond our control. If our actual results were to fall below our estimates or the expectations of public market analysts or investors, our quarterly and annual results would be negatively impacted and the price of our stock could decline. Other factors that could affect our quarterly and annual operating results include, but are not limited to:

 

    changes in the pricing policies of, or the introduction of new products by, us or our competitors;

 

    introductions of new technologies and changes in consumer preferences that result in either unanticipated or unexpectedly rapid product category shifts;

 

    slow or negative growth in the connected lifestyle, home electronics and related technology markets;

 

    seasonal shifts in end-market demand for our products;

 

    delays in the introduction of new products by us or market acceptance of these products;

 

    unanticipated decreases or delays in purchases of our products by our significant retailers, distributors and other channel partners;

 

    component supply constraints from our vendors;

 

    unanticipated increases in costs, including air freight, associated with shipping and delivery of our products;

 

    the inability to maintain stable operations by our suppliers and other parties with whom we have commercial relationships;

 

    discovery of security vulnerabilities in our products, services or systems, leading to negative publicity, decreased demand or potential liability;

 

    foreign currency exchange rate fluctuations in the jurisdictions where we transact sales and expenditures in local currency;

 

    excess levels of inventory and low turns;

 

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    changes in or consolidation of our sales channels and wholesale distributor relationships or failure to manage our sales channel inventory and warehousing requirements;

 

    delay or failure to fulfill orders for our products on a timely basis;

 

    delay or failure of our retailers, distributors and other channel partners to purchase at their historic volumes or at the volumes that they or we forecast;

 

    changes in tax rates or adverse changes in tax laws that expose us to additional income tax liabilities;

 

    changes in U.S. and international tax policy, including changes that adversely affect customs, tax or duty rates (such as the proposed higher tariffs on products imported from China recently announced by the Trump administration), as well as income tax legislation and regulations that affect the countries where we conduct business;

 

    operational disruptions, such as transportation delays or failure of our order processing system, particularly if they occur at the end of a fiscal quarter;

 

    disruptions or delays related to our financial and enterprise resource planning systems;

 

    our inability to accurately forecast product demand, resulting in increased inventory exposure;

 

    allowance for doubtful accounts exposure with our existing retailers, distributors and other channel partners and new retailers, distributors and other channel partners, particularly as we expand into new international markets;

 

    geopolitical disruption, including sudden changes in immigration policies, leading to disruption in our workforce or delay or even stoppage of our operations in manufacturing, transportation, technical support and research and development;

 

    terms of our contracts with channel partners or suppliers that cause us to incur additional expenses or assume additional liabilities;

 

    an increase in price protection claims, redemptions of marketing rebates, product warranty and stock rotation returns or allowance for doubtful accounts;

 

    litigation involving alleged patent infringement;

 

    epidemic or widespread product failure, or unanticipated safety issues, in one or more of our products;

 

    failure to effectively manage our third-party customer support partners, which may result in customer complaints and/or harm to the Arlo brand;

 

    our inability to monitor and ensure compliance with our code of ethics, our anti-corruption compliance program and domestic and international anti-corruption laws and regulations, whether in relation to our employees or with our suppliers or retailers, distributors or other channel partners;

 

    labor unrest at facilities managed by our third-party manufacturers;

 

    workplace or human rights violations in certain countries in which our third-party manufacturers or suppliers operate, which may affect the Arlo brand and negatively affect our products’ acceptance by consumers;

 

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    unanticipated shifts or declines in profit by geographical region that would adversely impact our tax rate;

 

    failure to implement and maintain the appropriate internal controls over financial reporting, which may result in restatements of our financial statements; and

 

    any changes in accounting rules.

As a result, period-to-period comparisons of our results of operations may not be meaningful, and you should not rely on them as an indication of our future performance.

If we fail to continue to introduce or acquire new products or services that achieve broad market acceptance on a timely basis, or if our products or services are not adopted as expected, we will not be able to compete effectively and we will be unable to increase or maintain revenue and gross margin.

We operate in a highly competitive, quickly changing environment, and our future success depends on our ability to develop or acquire, and introduce new products and services that achieve broad market acceptance. Our future success will depend in large part upon our ability to identify demand trends in the connected lifestyle market and quickly develop or acquire, and design, manufacture and sell, products and services that satisfy these demands in a cost-effective manner.

In order to differentiate our products and services from our competitors’ products, we must continue to increase our focus and capital investment in research and development, including software development. We have committed a substantial amount of resources to the manufacture, development and sale of our Arlo Smart services and our wire-free smart Wi-Fi cameras, advanced baby monitors and smart lights, and to introducing additional and improved models in these lines. In addition, we plan to continue to introduce new categories of smart connected devices to the Arlo platform in the near future. If our existing products and services do not continue, or if our new products or services fail to achieve widespread market acceptance, if existing customers do not subscribe to our paid subscription services such as Arlo Smart, or if we are unsuccessful in capitalizing on opportunities in the connected lifestyle market, as well as in the related market in the small business segment, our future growth may be slowed and our business, results of operations and financial condition could be materially adversely affected. Successfully predicting demand trends is difficult, and it is very difficult to predict the effect that introducing a new product or service will have on existing product or service sales. It is possible that Arlo may not be as successful with its new products and services, and as a result our future growth may be slowed and our business, results of operations and financial condition could be materially adversely affected. Also, we may not be able to respond effectively to new product or service announcements by our competitors by quickly introducing competitive products and services.

In addition, we may acquire companies and technologies in the future and, consistent with our vision for Arlo, introduce new product and service lines in the connected lifestyle market. In these circumstances, we may not be able to successfully manage integration of the new product and service lines with our existing suite of products and services. If we are unable to effectively and successfully further develop these new product and service lines, we may not be able to increase or maintain our sales, and our gross margin may be adversely affected.

We may experience delays and quality issues in releasing new products and services, which may result in lower quarterly revenue than expected. In addition, we may in the future experience product or service introductions that fall short of our projected rates of market adoption. Currently, reviews of our products and services are a significant factor in the success of our new product and service launches. If we are unable to generate a high number of positive reviews or quickly respond to negative reviews, including end-user reviews posted on various prominent online retailers, our ability to sell our products and services will be harmed. Any

 

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future delays in product and service development and introduction, or product and service introductions that do not meet broad market acceptance, or unsuccessful launches of new product and service lines could result in:

 

    loss of or delay in revenue and loss of market share;

 

    negative publicity and damage to our reputation and brand;

 

    a decline in the average selling price of our products and services;

 

    adverse reactions in our sales channels, such as reduced shelf space, reduced online product visibility or loss of sales channels; and

 

    increased levels of product returns.

Throughout the past few years, Arlo has significantly increased the rate of new product and service introductions, with the introduction of new lines of Arlo camera products and our smart light products, as well as the introduction of our Arlo Smart services. If we cannot sustain that pace of product and service introductions, either through rapid innovation or acquisition of new products and services or product and service lines, we may not be able to maintain or increase the market share of our products and services or expand further into the connected lifestyle market in accordance with our current plans. In addition, if we are unable to successfully introduce or acquire new products and services with higher gross margin, our revenue and overall gross margin would likely decline.

System security risks, data protection breaches and cyber-attacks could disrupt our products, services, internal operations or information technology systems, and any such disruption could reduce our expected revenue, increase our expenses, damage our reputation and cause our stock price to decline significantly.

Our products and services may contain unknown security vulnerabilities. For example, the firmware, software and open source software that we or our manufacturing partners have installed on our products may be susceptible to hacking or misuse. In addition, we offer a comprehensive online cloud management service paired with our end products, including our cameras, baby monitors and smart lights. If malicious actors compromise this cloud service, or if customer confidential information is accessed without authorization, our business will be harmed. Operating an online cloud service is a relatively new business for us, and we may not have the expertise to properly manage risks related to data security and systems security. We rely on third-party providers for a number of critical aspects of our cloud services and customer support, including web hosting services, billing and payment processing, and consequently we do not maintain direct control over the security or stability of the associated systems. If we or our third-party providers are unable to successfully prevent breaches of security relating to our products, services or user private information, including user videos and user personal identification information, or if these third-party systems fail for other reasons, our management could need to spend increasing amounts of time and effort in this area. As a result, we could incur substantial expenses, our brand and reputation could suffer and our business, results of operations and financial condition could be materially adversely affected.

Maintaining the security of our computer information systems and communication systems is a critical issue for us and our customers. Malicious actors may develop and deploy malware that is designed to manipulate our systems, including our internal network, or those of our vendors or customers. Additionally, outside parties may attempt to fraudulently induce our employees to disclose sensitive information in order to gain access to our information technology systems, our data or our customers’ data. We have established a crisis management plan and business continuity program. While we regularly test the plan and the program, there can be no assurance that the plan and program can withstand an actual or serious disruption in our business, including cyber-attack. While we have established service-level and geographic redundancy for our critical systems, our ability to utilize these redundant systems must be tested regularly, failing over to such systems always carries risk and we cannot

 

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be assured that such systems are fully functional. For example, much of our order fulfillment process is automated and the order information is stored on our servers. A significant business interruption could result in losses or damages and harm our business. If our computer systems and servers become unavailable at the end of a fiscal quarter, our ability to recognize revenue may be delayed until we are able to utilize back-up systems and continue to process and ship our orders. This could cause our stock price to decline significantly.

We devote considerable internal and external resources to network security, data encryption and other security measures to protect our systems, customers and users, but these security measures cannot provide absolute security. Potential breaches of our security measures and the accidental loss, inadvertent disclosure or unapproved dissemination of proprietary information or sensitive or confidential data about us, our employees or our customers or users, including the potential loss or disclosure of such information or data as a result of employee error or other employee actions, hacking, fraud, social engineering or other forms of deception could expose us, our customers or the individuals affected to a risk of loss or misuse of this information, result in litigation and potential liability for us, damage our brand and reputation or otherwise materially adversely affect our business, results of operations and financial condition. In addition, the cost and operational consequences of implementing further data protection measures could be significant.

Interruptions with the cloud-based systems that we use in our operations provided by an affiliate of Amazon.com, Inc. (“Amazon”), which is also one of our primary competitors, may materially adversely affect our business, results of operations and financial condition.

We host our platform using Amazon Web Services (“AWS”) data centers, a provider of cloud infrastructure services, and may in the future use other third-party cloud-based systems in our operations. All of our solutions currently reside on systems leased and operated by us in these locations. Accordingly, our operations depend on protecting the virtual cloud infrastructure hosted in AWS by maintaining its configuration, architecture, features and interconnection specifications, as well as the information stored in these virtual data centers and which third-party internet service providers transmit. Although we have disaster recovery plans that utilize multiple AWS locations, any incident affecting their infrastructure that may be caused by human error, fire, flood, severe storm, earthquake or other natural disasters, cyber-attacks, terrorist or other attacks, and other similar events beyond our control could negatively affect our platform. A prolonged AWS service disruption affecting our platform for any of the foregoing reasons would negatively impact our ability to serve our end-users and could damage our reputation with current and potential end-users, expose us to liability, cause us to lose customers or otherwise harm our business. We may also incur significant costs for using alternative equipment or taking other actions in preparation for, or in reaction to, events that damage the AWS services we use. Further, if we were to make updates to our platforms that were not compatible with the configuration, architecture, features and interconnection specifications of the third-party platform, our service could be disrupted.

Under the terms of AWS’s agreements with us, it may terminate its agreement by providing us with 30 days’ prior written notice. In addition, Amazon also produces the Amazon Cloud Cam, which competes with our security camera products, and recently acquired two of our competitors, Blink and Ring. Amazon may choose to hamper our competitive efforts, using provision of AWS services as leverage. In the event that our AWS service agreements are terminated, or there is a lapse of service, elimination of AWS services or features that we use, interruption of internet service provider connectivity or damage to such facilities, we could experience interruptions in access to our platform as well as significant delays and additional expense in arranging or creating new facilities and services and/or re-architecting our solutions for deployment on a different cloud infrastructure service provider, which could materially adversely affect our business, results of operations and financial condition.

 

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Some of our competitors have substantially greater resources than we do, and to be competitive we may be required to lower our prices or increase our sales and marketing expenses, which could result in reduced margins and loss of market share.

We compete in a rapidly evolving and fiercely competitive market, and we expect competition to continue to be intense, including price competition. Our principal competitors include Amazon (Blink and Ring), Google (Nest), Swann, Night Owl, Foxconn Corporation (Belkin), Samsung, D-Link and Canary. Other competitors include numerous local vendors such as Netatmo, Logitech, Bosch, Instar and Uniden. In addition, these local vendors may target markets outside of their local regions and may increasingly compete with us in other regions worldwide. Many of our existing and potential competitors have longer operating histories, greater brand recognition and substantially greater financial, technical, sales, marketing and other resources. These competitors may, among other things, undertake more extensive marketing campaigns, adopt more aggressive pricing policies, obtain more favorable pricing from suppliers and manufacturers, and exert more influence on sales channels than we can. In addition, certain competitors may have different business models, such as integrated manufacturing capabilities, that may allow them to achieve cost savings and to compete on the basis of price. Other competitors may have fewer resources, but may be more nimble in developing new or disruptive technology or in entering new markets.

We anticipate that current and potential competitors will also intensify their efforts to penetrate our target markets. For example, price competition is intense in our industry in certain geographical regions and product categories. Many of our competitors price their products significantly below our product costs. Average sales prices have declined in the past and may again decline in the future. These competitors may have more advanced technology, more extensive distribution channels, stronger brand names, greater access to shelf space in retail locations, bigger promotional budgets and larger retailers, distributors and other channel partners and end-user bases than we do.

In addition, many of these competitors leverage a broader product portfolio and offer lower pricing as part of a more comprehensive end-to-end solution. These companies could devote more capital resources to develop, manufacture and market competing products than we could.

Our competitors may also acquire other companies in the market and leverage combined resources to gain market share. If any of these companies are successful in competing against us, our sales could decline, our margins could be negatively impacted and we could lose market share, any of which could seriously harm our business, financial condition and results of operations.

We rely on a limited number of traditional and online retailers and wholesale distributors for a substantial portion of our sales, and our revenue could decline if they refuse to pay our requested prices or reduce their level of purchases or if there is significant consolidation in our sales channels, which results in fewer sales channels for our products.

We sell a substantial portion of our products through traditional and online retailers, including Best Buy Co., Inc. (“Best Buy”), Amazon, Costco Wholesale Corporation (“Costco”) and their respective affiliates. For the year ended December 31, 2017, we derived 28%, 16% and 13% of our revenue from Best Buy, Amazon and Costco and their respective affiliates, respectively. In addition, we sell to wholesale distributors, including Ingram Micro, Inc., D&H Distributing Company, Exertis (UK) Ltd. and Synnex Corporation. We expect that a significant portion of our revenue will continue to come from sales to a small number of such retailers, distributors and other channel partners. In addition, because our accounts receivable are often concentrated within a small group of retailers, distributors and other channel partners, the failure of any of them to pay on a timely basis, or at all, would reduce our cash flow. We are also exposed to increased credit risk if any one of these limited numbers of retailer and distributor channel partners fails or becomes insolvent. We generally have no minimum purchase commitments or long-term contracts with any of these retailers, distributors and other channel partners. These purchasers could decide at any time to discontinue, decrease or delay their purchases of

 

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our products. If our retailers, distributors and other channel partners increase the size of their product orders without sufficient lead-time for us to process the order, our ability to fulfill product orders would be compromised. These channel partners have a variety of suppliers to choose from and therefore can make substantial demands on us, including demands on product pricing and on contractual terms, which often results in the allocation of risk to us as the supplier. Accordingly, the prices that they pay for our products are subject to negotiation and could change at any time. We have historically benefitted from NETGEAR’s strong relationships with these retailers, distributors and other channel partners, and we may not be able to maintain these relationships following our separation from NETGEAR. Our ability to maintain strong relationships with these channel partners is essential to our future performance. If any of our major channel partners reduce their level of purchases or refuse to pay the prices that we set for our products, our revenue and results of operations could be harmed. The traditional retailers that purchase from us have faced increased and significant competition from online retailers. If our key traditional retailers continue to reduce their level of purchases from us, our business, results of operations and financial condition could be harmed.

Additionally, concentration and consolidation among our channel partner base may allow certain retailers and distributors to command increased leverage in negotiating prices and other terms of sale, which could adversely affect our profitability. In addition, if, as a result of increased leverage, channel partner pressures require us to reduce our pricing such that our gross margin is diminished, we could decide not to sell our products to a particular channel partner, which could result in a decrease in our revenue. Consolidation among our channel partner base may also lead to reduced demand for our products, elimination of sales opportunities, replacement of our products with those of our competitors and cancellations of orders, each of which could materially adversely affect our business, results of operations and financial condition. If consolidation among the retailers, distributors or other channel partners who purchase our products becomes more prevalent, our business, results of operations and financial condition could be materially adversely affected.

In particular, the retail and connected home markets in some countries, including the United States, are dominated by a few large retailers with many stores. These retailers have in the past increased their market share and may continue to do so in the future by expanding through acquisitions and construction of additional stores. These situations concentrate our credit risk with a relatively small number of retailers, and, if any of these retailers were to experience a shortage of liquidity, it could increase the risk that their outstanding payables to us may not be paid. In addition, increasing market share concentration among one or a few retailers in a particular country or region increases the risk that if any one of them substantially reduces its purchases of our devices, we may be unable to find a sufficient number of other retail outlets for our products to sustain the same level of sales. Any reduction in sales by our retailers could materially adversely affect our business, results of operations and financial condition.

Our current and future products may experience quality problems, including defects or errors, from time to time that can result in adverse publicity, product recalls, litigation, regulatory proceedings, and warranty claims resulting in significant direct or indirect costs, decreased revenue and operating margin, and harm to our brand.

We sell complex products that could contain design and manufacturing defects in their materials, hardware and firmware. These defects could include defective materials or components that can unexpectedly interfere with the products’ intended operations or cause injuries to users or property damage. Although we extensively and rigorously test new and enhanced products and services before their release, we cannot assure we will be able to detect, prevent or fix all defects. Failure to detect, prevent or fix defects, or an increase in defects, could result in a variety of consequences, including a greater number of product returns than expected from users and retailers, increases in warranty costs, regulatory proceedings, product recalls and litigation, each of which could materially adversely affect our business, results of operations and financial condition. We generally provide a one-year hardware warranty on all of our products. The occurrence of real or perceived quality problems or material defects in our current and future products could expose us to warranty claims in excess of our current reserves. If we experience greater returns from retailers or users, or greater warranty claims, in excess

 

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of our reserves, our business, financial condition and results of operations could be harmed. In addition, any negative publicity or lawsuits filed against us related to the perceived quality and safety of our products could also adversely affect our brand, decrease demand for our products and services and materially adversely affect our business, results of operations and financial condition.

In addition, epidemic failure clauses are found in certain of our customer contracts. If invoked, these clauses may entitle the customer to return for replacement or obtain credits for products and inventory, as well as assess liquidated damage penalties and terminate an existing contract and cancel future or then-current purchase orders. In such instances, we may also be obligated to cover significant costs incurred by the customer associated with the consequences of such epidemic failure, including freight and transportation required for product replacement and out-of-pocket costs for truck rolls to end-user sites to collect the defective products. Costs or payments we make in connection with an epidemic failure could materially adversely affect our business, results of operations and financial condition.

If our products contain defects or errors, or are found to be noncompliant with industry standards, we could experience decreased sales and increased product returns, loss of customers and market share, and increased service, warranty and insurance costs. In addition, defects in, or misuse of, certain of our products could cause safety concerns, including the risk of property damage or personal injury. If any of these events occurred, our reputation and brand could be damaged, and we could face product liability or other claims regarding our products, resulting in unexpected expenses and adversely impacting our operating results. For instance, if a third party were able to successfully overcome the security measures in our products, such a person or entity could misappropriate end-user data, third-party data stored by our users and other information, including intellectual property. If that happens, affected end-users or others may file actions against us alleging product liability, tort or breach of warranty claims.

We depend on large, recurring purchases from certain significant retailers, distributors and other channel partners, and a loss, cancellation or delay in purchases by these channel partners could negatively affect our revenue.

The loss of recurring orders from any of our more significant retailers, distributors and other channel partners could cause our revenue and profitability to suffer. Our ability to attract new retailers, distributors and other channel partners will depend on a variety of factors, including the cost-effectiveness, reliability, scalability, breadth and depth of our products. In addition, a change in the mix of our retailers, distributors and other channel partners, or a change in the mix of direct and indirect sales, could adversely affect our revenue and gross margin.

Although our financial performance may depend on large, recurring orders from certain retailers, distributors and other channel partners, we do not generally have binding commitments from them. For example:

 

    our channel partner agreements generally do not require minimum purchases;

 

    our retailers, distributors and other channel partners can stop purchasing and stop marketing our products at any time; and

 

    our channel partner agreements generally are not exclusive.

Further, our revenue may be impacted by significant one-time purchases that are not contemplated to be repeatable. While such purchases are reflected in our financial statements, we do not rely on and do not forecast for continued significant one-time purchases. As a result, lack of repeatable one-time purchases will adversely affect our revenue.

Because our expenses are based on our revenue forecasts, a substantial reduction or delay in sales of our products to, or unexpected returns from, channel partners, or the loss of any significant channel partners, could

 

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materially adversely affect our business, results of operations and financial condition. Although our largest channel partners may vary from period to period, we anticipate that our results of operations for any given period will continue to depend on large orders from a small number of channel partners.

The average selling prices of our products typically decrease rapidly over the sales cycle of the product, which may negatively affect our revenue and gross margin.

Our products typically experience price erosion, a fairly rapid reduction in the average unit selling prices over their sales cycles. In order to sell products that have a falling average unit selling price and maintain margins at the same time, we need to continually reduce product and manufacturing costs. To manage manufacturing costs, we must partner with our third-party manufacturers to engineer the most cost-effective design for our products. In addition, we must carefully manage the price paid for components used in our products, and we must also successfully manage our freight and inventory costs to reduce overall product costs. We also need to continually introduce new products with higher sales prices and gross margin in order to maintain our overall gross margin. If we are unable to manage the cost of older products or successfully introduce new products with higher gross margin, our revenue and overall gross margin would likely decline.

The reputation of our services may be damaged, and we may face significant direct or indirect costs, decreased revenue and operating margins if our services contain significant defects or fail to perform as intended.

Our services, including our intelligent cloud and App platform and our Arlo Smart services, are complex, and may not always perform as intended due to outages of our systems or defects affecting our services. Systems outages could be disruptive to our business and damage the reputation of our services and result in potential loss of revenue.

Significant defects affecting our services may be found following the introduction of new software or enhancements to existing software or in software implementations in varied information technology environments. Internal quality assurance testing and end-user testing may reveal service performance issues or desirable feature enhancements that could lead us to reallocate service development resources or postpone the release of new versions of our software. The reallocation of resources or any postponement could cause delays in the development and release of future enhancements to our currently available software, damage the reputation of our services in the marketplace and result in potential loss of revenue. Although we attempt to resolve all errors that we believe would be considered serious by our partners and customers, the software powering our services is not error-free. Undetected errors or performance problems may be discovered in the future, and known errors that we consider minor may be considered serious by our channel partners and end-users.

System disruptions and defects in our services could result in lost revenue, delays in customer deployment or legal claims and could be detrimental to our reputation.

Because we store, process and use data, some of which contain personal information, we are subject to complex and evolving federal, state and foreign laws and regulations regarding privacy, data protection and other matters, which are subject to change.

We are subject to a variety of laws and regulations in the United States and other countries that involve matters central to our business, including with respect to user privacy, rights of publicity, data protection, content, protection of minors and consumer protection. These laws can be particularly restrictive in countries outside the United States. Both in the United States and abroad, these laws and regulations constantly evolve and remain subject to significant change. In addition, the application and interpretation of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate. Because we store, process and use data, some of which contain personal information, we are subject to complex and evolving federal, state and foreign laws and regulations regarding privacy, data protection and other matters. Many of

 

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these laws and regulations are subject to change and uncertain interpretation and could result in investigations, claims, changes to our business practices, increased cost of operations and declines in user growth, retention or engagement, any of which could materially adversely affect our business, results of operations and financial condition.

Several proposals are pending before federal, state and foreign legislative and regulatory bodies that could significantly affect our business. For example, a revision to the 1995 European Union Data Protection Directive is currently being considered by European legislative bodies that may include more stringent operational requirements for data processors and significant penalties for non-compliance. In addition, the EU General Data Protection Regulation 2016/679 (“GDPR”), which came into effect on May 25, 2018, establishes new requirements applicable to the processing of personal data (i.e., data which identifies an individual or from which an individual is identifiable), affords new data protection rights to individuals (e.g., the right to erasure of personal data) and imposes penalties for serious data breaches. Individuals also have a right to compensation under GDPR for financial or non-financial losses. GDPR will impose additional responsibility and liability in relation to our processing of personal data. GDPR may require us to change our policies and procedures and, if we are not compliant, could materially adversely affect our business, results of operations and financial condition.

Our stock price may be volatile and your investment in our common stock could suffer a decline in value.

There has been significant volatility in the market price and trading volume of securities of technology and other companies, which may be unrelated to the financial performance of these companies. These broad market fluctuations may negatively affect the market price of our common stock.

Some specific factors that may have a significant effect on the market price of our common stock include:

 

    actual or anticipated fluctuations in our results of operations or our competitors’ operating results;

 

    actual or anticipated changes in the growth rate of the connected lifestyle market, our growth rates or our competitors’ growth rates;

 

    conditions in the financial markets in general or changes in general economic conditions;

 

    changes in governmental regulation, including taxation and tariff policies;

 

    interest rate or currency exchange rate fluctuations;

 

    our ability to forecast or report accurate financial results; and

 

    changes in stock market analyst recommendations regarding our common stock, other comparable companies or our industry generally.

We obtain several key components from limited or sole sources, and if these sources fail to satisfy our supply requirements or we are unable to properly manage our supply requirements with our third-party manufacturers, we may lose sales and experience increased component costs.

Any shortage or delay in the supply of key product components would harm our ability to meet scheduled product deliveries. Many of the components used in our products are specifically designed for use in our products, some of which are obtained from sole source suppliers. These components include lens, lens-sensors and passive infrared (“PIR”) sensors that have been customized for the Arlo application, as well as

 

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custom-made batteries that provide power conservation and safety features. In addition, the components used in our end products have been optimized to extend battery life. Our third-party manufacturers generally purchase these components on our behalf, and we do not have any contractual commitments or guaranteed supply arrangements with our suppliers. If demand for a specific component increases, we may not be able to obtain an adequate number of that component in a timely manner. In addition, if worldwide demand for the components increases significantly, the availability of these components could be limited. Further, our suppliers may experience financial or other difficulties as a result of uncertain and weak worldwide economic conditions. Other factors that may affect our suppliers’ ability or willingness to supply components to us include internal management or reorganizational issues, such as roll-out of new equipment which may delay or disrupt supply of previously forecasted components, or industry consolidation and divestitures, which may result in changed business and product priorities among certain suppliers. It could be difficult, costly and time consuming to obtain alternative sources for these components, or to change product designs to make use of alternative components. In addition, difficulties in transitioning from an existing supplier to a new supplier could create delays in component availability that would have a significant impact on our ability to fulfill orders for our products.

We provide our third-party manufacturers with a rolling forecast of demand, which they use to determine our material and component requirements. Lead times for ordering materials and components vary significantly and depend on various factors, such as the specific supplier, contract terms and demand and supply for a component at a given time. Some of our components have long lead times, such as wireless local area network chipsets, physical layer transceivers, connector jacks and metal and plastic enclosures. If our forecasts are not timely provided or are less than our actual requirements, our third-party manufacturers may be unable to manufacture products in a timely manner. If our forecasts are too high, our third-party manufacturers will be unable to use the components they have purchased on our behalf. The cost of the components used in our products tends to drop rapidly as volumes increase and the technologies mature. Therefore, if our third-party manufacturers are unable to promptly use components purchased on our behalf, our cost of producing products may be higher than our competitors due to an oversupply of higher-priced components. Moreover, if they are unable to use components ordered at our direction, we will need to reimburse them for any losses they incur.

If we are unable to obtain a sufficient supply of components, or if we experience any interruption in the supply of components, our product shipments could be reduced or delayed or our cost of obtaining these components may increase. Component shortages and delays affect our ability to meet scheduled product deliveries, damage our brand and reputation in the market, and cause us to lose sales and market share. For example, component shortages and disruptions in supply in the past have limited our ability to supply all the worldwide demand for our products, and our revenue was affected. At times, we have elected to use more expensive transportation methods, such as air freight, to make up for manufacturing delays caused by component shortages, which reduces our margins. In addition, at times sole suppliers of highly specialized components have provided components that were either defective or did not meet the criteria required by our retailers, distributors or other channel partners, resulting in delays, lost revenue opportunities and potentially substantial write-offs.

We depend on a limited number of third-party manufacturers for substantially all of our manufacturing needs. If these third-party manufacturers experience any delay, disruption or quality control problems in their operations, we could lose market share and our brand may suffer.

All of our products are manufactured, assembled, tested and generally packaged by a limited number of third-party original design manufacturers (“ODMs”). In most cases, we rely on these manufacturers to procure components and, in some cases, subcontract engineering work. We currently outsource manufacturing to Foxconn Corporation, Sky Light Industrial Ltd. and Delta Networks, Inc. We do not have any long-term contracts with any of these third-party manufacturers, although we have executed product supply agreements with these manufacturers, which typically provide indemnification for intellectual property infringement, epidemic failure clauses, agreed-upon price concessions and certain product quality requirements. Some of these third-party manufacturers produce products for our competitors. In addition, one of our principal manufacturers, Foxconn Corporation, has entered into a definitive agreement to acquire Belkin International, which includes the

 

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WeMo brand of home automation products, which may compete directly with us. Due to changing economic conditions, the viability of some of these third-party manufacturers may be at risk. The loss of the services of any of our primary third-party manufacturers could cause a significant disruption in operations and delays in product shipments. Qualifying a new manufacturer and commencing volume production is expensive and time consuming. Ensuring that a contract manufacturer is qualified to manufacture our products to our standards is time consuming. In addition, there is no assurance that a contract manufacturer can scale its production of our products at the volumes and in the quality that we require. If a contract manufacturer is unable to do these things, we may have to move production for the products to a new or existing third-party manufacturer, which would take significant effort and our business, results of operations and financial condition could be materially adversely affected. In addition, as we contemplate moving manufacturing into different jurisdictions, we may be subject to additional significant challenges in ensuring that quality, processes and costs, among other issues, are consistent with our expectations. For example, while we expect our manufacturers to be responsible for penalties assessed on us because of excessive failures of the products, there is no assurance that we will be able to collect such reimbursements from these manufacturers, which causes us to take on additional risk for potential failures of our products.

Our reliance on third-party manufacturers also exposes us to the following risks over which we have limited control:

 

    unexpected increases in manufacturing and repair costs;

 

    inability to control the quality and reliability of finished products;

 

    inability to control delivery schedules;

 

    potential liability for expenses incurred by third-party manufacturers in reliance on our forecasts that later prove to be inaccurate;

 

    potential lack of adequate capacity to manufacture all or a part of the products we require; and

 

    potential labor unrest affecting the ability of the third-party manufacturers to produce our products.

All of our products must satisfy safety and regulatory standards and some of our products must also receive government certifications. Our third-party manufacturers are primarily responsible for conducting the tests that support our applications for most regulatory approvals for our products. If our third-party manufacturers fail to timely and accurately conduct these tests, we would be unable to obtain the necessary domestic or foreign regulatory approvals or certificates to sell our products in certain jurisdictions. As a result, we would be unable to sell our products and our sales and profitability could be reduced, our relationships with our sales channel could be harmed, and our reputation and brand would suffer.

Specifically, substantially all of our manufacturing and assembly occurs in the Asia Pacific region, primarily in Vietnam, and any disruptions due to natural disasters, health epidemics and political, social and economic instability in the region would affect the ability of our third-party manufacturers to manufacture our products. In particular, in the event the labor market in Vietnam becomes saturated, our third-party manufacturers in Vietnam may increase our costs of production. If these costs increase, it may affect our margins and ability to lower prices for our products to stay competitive. Labor unrest may also affect our third-party manufacturers, as workers may strike and cause production delays. If our third-party manufacturers fail to maintain good relations with their employees or contractors, and production and manufacturing of our products are affected, then we may be subject to shortages of products and the quality of products delivered may be affected. Further, if our manufacturers or warehousing facilities are disrupted or destroyed, we could have no other readily available alternatives for manufacturing and assembling our products, and our business, results of operations and financial condition could be materially adversely affected.

 

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In the future, we may work with more third-party manufacturers on a contract manufacturing basis, which could result in our exposure to additional risks not inherent in a typical ODM arrangement. Such risks may include our inability to properly source and qualify components for the products, lack of software expertise resulting in increased software defects, and lack of resources to properly monitor the manufacturing process. In our typical ODM arrangement, our ODMs are generally responsible for sourcing the components of the products and warranting that the products will work according to a product’s specification, including any software specifications. In a contract manufacturing arrangement, we would take on much more, if not all, of the responsibility around these areas. If we are unable to properly manage these risks, our products may be more susceptible to defects, and our business, results of operations and financial condition could be materially adversely affected.

We depend substantially on our sales channels, and our failure to maintain and expand our sales channels would result in lower sales and reduced revenue.

To maintain and grow our market share, revenue and brand, we must maintain and expand our sales channels. Our sales channels consist primarily of traditional retailers, online retailers and wholesale distributors, but also include service providers such as wireless carriers and telecommunications providers. We generally have no minimum purchase commitments or long-term contracts with any of these third parties.

Traditional retailers have limited shelf space and promotional budgets, and competition is intense for these resources. A competitor with more extensive product lines and stronger brand identity may have greater bargaining power with these retailers. Any reduction in available shelf space or increased competition for such shelf space would require us to increase our marketing expenditures simply to maintain current levels of retail shelf space, which would harm our operating margin. Our traditional retail customers have faced increased and significant competition from online retailers. If we cannot effectively manage our business amongst our online customers and traditional retail customers, our business would be harmed. The recent trend in the consolidation of online retailers has resulted in intensified competition for preferred product placement, such as product placement on an online retailer’s internet home page. In addition, our efforts to realign or consolidate our sales channels may cause temporary disruptions in our product sales and revenue, and these efforts may not result in the expected longer-term benefits that prompted them.

In addition, to the extent our retail and distributor channel partners supply products that compete with our own, it is possible that these channel partners may choose not to offer our products to end-users or to offer our products to end-users on less favorable terms, including with respect to product placement. If this were to occur, we may not be able to increase or maintain our sales, and our business, results of operations and financial condition could be materially adversely affected. For example, Amazon, one of our primary retailers, produces the Amazon Cloud Cam, which competes with our security camera products, and also recently acquired two of our competitors, Blink and Ring. For the year ended December 31, 2017, we derived 16% of our revenue from Amazon and its affiliates.

We must also continuously monitor and evaluate emerging sales channels. If we fail to establish a presence in an important developing sales channel, our business, results of operations and financial condition could be materially adversely affected.

If disruptions in our transportation network occur or our shipping costs substantially increase, we may be unable to sell or timely deliver our products, and our operating expenses could increase.

We are highly dependent upon the transportation systems we use to ship our products, including surface and air freight. Our attempts to closely match our inventory levels to our product demand intensify the need for our transportation systems to function effectively and without delay. On a quarterly basis, our shipping volume also tends to steadily increase as the quarter progresses, which means that any disruption in our transportation network in the latter half of a quarter will likely have a more material effect on our business than at the beginning of a quarter.

 

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The transportation network is subject to disruption or congestion from a variety of causes, including labor disputes or port strikes, acts of war or terrorism, natural disasters and congestion resulting from higher shipping volumes. Labor disputes among freight carriers and at ports of entry are common, particularly in Europe, and we expect labor unrest and its effects on shipping our products to be a continuing challenge for us. A port worker strike, work slow-down or other transportation disruption in Long Beach, California, where we import our products to fulfill our Americas orders, could significantly disrupt our business. Our international freight is regularly subjected to inspection by governmental entities. If our delivery times increase unexpectedly for these or any other reasons, our ability to deliver products on time would be materially adversely affected and result in delayed or lost revenue as well as customer imposed penalties. In addition, if increases in fuel prices occur, our transportation costs would likely increase. Moreover, the cost of shipping our products by air freight is greater than other methods. From time to time in the past, we have shipped products using extensive air freight to meet unexpected spikes in demand and shifts in demand between product categories, to bring new product introductions to market quickly and to timely ship products previously ordered. If we rely more heavily upon air freight to deliver our products, our overall shipping costs will increase. A prolonged transportation disruption or a significant increase in the cost of freight could materially adversely affect our business, results of operations and financial condition.

If we lose the services of key personnel, we may not be able to execute our business strategy effectively.

Our future success depends in large part upon the continued services of our key technical, engineering, sales, marketing, finance and senior management personnel. The competition for qualified personnel with significant experience in the design, development, manufacturing, marketing and sales in the markets in which we operate is intense, both where our U.S. operations are based, including Silicon Valley, and in global markets in which we operate. Our inability to attract qualified personnel, including hardware and software engineers and sales and marketing personnel, could delay the development and introduction of, and harm our ability to sell, our products and services. Changes to U.S. immigration policies that restrict our ability to attract and retain technical personnel may negatively affect our research and development efforts.

We do not maintain any key person life insurance policies. Our business model requires extremely skilled and experienced senior management who are able to withstand the rigorous requirements and expectations of our business. Our success depends on senior management being able to execute at a very high level. The loss of any of our senior management or other key engineering, research, development, sales or marketing personnel, particularly if lost to competitors, could harm our ability to implement our business strategy and respond to the rapidly changing needs of our business. If we suffer the loss of services of any key executive or key personnel, our business, results of operations and financial condition could be materially adversely affected. In addition, we may not be able to have the proper personnel in place to effectively execute our long-term business strategy if key personnel retire, resign or are otherwise terminated.

If we are unable to secure and protect our intellectual property rights, our ability to compete could be harmed.

We rely on a combination of copyright, trademark, patent and trade secret laws, nondisclosure agreements with employees, consultants and suppliers and other contractual provisions to establish, maintain and protect our intellectual property and technology. Despite efforts to protect our intellectual property, unauthorized third parties may attempt to design around, copy aspects of our product design or obtain and use technology or other intellectual property associated with our products. Furthermore, our competitors may independently develop similar technology or design around our intellectual property. Our inability to secure and protect our intellectual property rights could materially adversely affect our brand and business, results of operations and financial condition.

 

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We rely upon third parties for technology that is critical to our products, and if we are unable to continue to use this technology and future technology, our ability to develop, sell, maintain and support technologically innovative products would be limited.

We rely on third parties to obtain non-exclusive patented hardware and software license rights in technologies that are incorporated into and necessary for the operation and functionality of most of our products. In these cases, because the intellectual property we license is available from third parties, barriers to entry into certain markets may be lower for potential or existing competitors than if we owned exclusive rights to the technology that we license and use. Moreover, if a competitor or potential competitor enters into an exclusive arrangement with any of our key third-party technology providers, or if any of these providers unilaterally decides not to do business with us for any reason, our ability to develop and sell products containing that technology would be severely limited. In addition, certain of Arlo’s firmware and the AI-based algorithms that we use in our Arlo Smart services incorporate open source software, the licenses for which may include customary requirements for, and restrictions on, use of the open source software.

If we are offering products or services that contain third-party technology that we subsequently lose the right to license, then we will not be able to continue to offer or support those products or services. In addition, these licenses may require royalty payments or other consideration to the third-party licensor. Our success will depend, in part, on our continued ability to access these technologies, and we do not know whether these third-party technologies will continue to be licensed to us on commercially acceptable terms, if at all. In addition, if these third-party licensors fail or experience instability, then we may be unable to continue to sell products and services that incorporate the licensed technologies, in addition to being unable to continue to maintain and support these products and services. We do require escrow arrangements with respect to certain third-party software which entitle us to certain limited rights to the source code, in the event of certain failures by the third party, in order to maintain and support such software. However, there is no guarantee that we would be able to fully understand and use the source code, as we may not have the expertise to do so. We are increasingly exposed to these risks as we continue to develop and market more products containing third-party technology and software. If we are unable to license the necessary technology, we may be forced to acquire or develop alternative technology, which could be of lower quality or performance standards. The acquisition or development of alternative technology may limit and delay our ability to offer new or competitive products and services and increase our costs of production. As a result, our business, results of operations and financial condition could be materially adversely affected.

We also utilize third-party software development companies and contractors to develop, customize, maintain and support software that is incorporated into our products and services. If these companies and contractors fail to timely deliver or continuously maintain and support the software, as we require of them, we may experience delays in releasing new products and services or difficulties with supporting existing products, services and our users.

Our sales and operations in international markets expose us to operational, financial and regulatory risks.

International sales comprise a significant amount of our overall revenue. International sales were 25% of overall revenue in fiscal year 2017 and 23% of overall revenue in fiscal year 2016. We continue to be committed to growing our international sales, and while we have committed resources to expanding our international operations and sales channels, these efforts may not be successful. International operations are subject to a number of other risks, including:

 

    exchange rate fluctuations;

 

    political and economic instability, international terrorism and anti-American sentiment, particularly in emerging markets;

 

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    potential for violations of anti-corruption laws and regulations, such as those related to bribery and fraud;

 

    preference for locally branded products, and laws and business practices favoring local competition;

 

    potential consequences of, and uncertainty related to, the “Brexit” process in the United Kingdom, which could lead to additional expense and complexity in doing business there;

 

    increased difficulty in managing inventory;

 

    delayed revenue recognition;

 

    less effective protection of intellectual property;

 

    stringent consumer protection and product compliance regulations, including but not limited to General Data Protection Regulation in the European Union, European competition law, the Restriction of Hazardous Substances directive, the Waste Electrical and Electronic Equipment directive and the European Ecodesign directive that are costly to comply with and may vary from country to country;

 

    difficulties and costs of staffing and managing foreign operations;

 

    business difficulties, including potential bankruptcy or liquidation, of any of our worldwide third-party logistics providers, such as Kerry Logistics; and

 

    changes in local tax and customs duty laws or changes in the enforcement, application or interpretation of such laws.

We are also required to comply with local environmental legislation, and those who sell our products rely on this compliance in order to sell our products. If those who sell our products do not agree with our interpretations and requirements of new legislation, they may cease to order our products and our business, results of operations and financial condition could be materially adversely affected.

The development of our operations and infrastructure in connection with our separation from NETGEAR, and any future expansion of such operations and infrastructure, may not be entirely successful, and may strain our operations and increase our operating expenses.

In connection with our separation from NETGEAR, we have been implementing a new information technology infrastructure for our business, which includes the creation of management information systems and operational and financial controls unique to our business. We may not be able to put in place adequate controls in an efficient and timely manner in connection with our separation from NETGEAR and as our business grows, and our current systems may not be adequate to support our future operations. The difficulties associated with installing and implementing new systems, procedures and controls may place a significant burden on our management and operational and financial resources. In addition, as we grow internationally, we will have to expand and enhance our communications infrastructure. If we fail to continue to improve our management information systems, procedures and financial controls, or encounter unexpected difficulties during expansion and reorganization, our business could be harmed.

For example, we are investing significant capital and human resources in the design, development and enhancement of our financial and enterprise resource planning systems. We will depend on these systems in order to timely and accurately process and report key components of our results of operations, financial condition and cash flows. If the systems fail to operate appropriately or we experience any disruptions or delays in

 

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enhancing their functionality to meet current business requirements, our ability to fulfill customer orders, bill and track our customers, fulfill contractual obligations, accurately report our financials and otherwise run our business could be adversely affected. Even if we do not encounter these adverse effects, the development and enhancement of systems may be much more costly than we anticipated. If we are unable to continue to develop and enhance our information technology systems as planned, our business, results of operations and financial condition could be materially adversely affected.

Governmental regulations of imports or exports affecting internet security could affect our revenue.

Any additional governmental regulation of imports or exports or failure to obtain required export approval of our encryption technologies could adversely affect our international and domestic sales. The United States and various foreign governments have imposed controls, export license requirements and restrictions on the import or export of some technologies, particularly encryption technology. In addition, from time to time, governmental agencies have proposed additional regulation of encryption technology, such as requiring the escrow and governmental recovery of private encryption keys. In response to terrorist activity, governments could enact additional regulation or restriction on the use, import or export of encryption technology. This additional regulation of encryption technology could delay or prevent the acceptance and use of encryption products and public networks for secure communications, resulting in decreased demand for our products and services. In addition, some foreign competitors are subject to less stringent controls on exporting their encryption technologies. As a result, they may be able to compete more effectively than we can in the United States and the international internet security market.

We are involved in litigation matters in the ordinary course and may in the future become involved in additional litigation, including litigation regarding intellectual property rights, which could be costly and subject us to significant liability.

Our industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding infringement of patents, trade secrets and other intellectual property rights. From time to time, third parties have asserted, and may continue to assert, exclusive patent, copyright, trademark and other intellectual property rights against us, demanding license or royalty payments or seeking payment for damages, injunctive relief and other available legal remedies through litigation. These also include third-party non-practicing entities who claim to own patents or other intellectual property that they believe cover our products. If we are unable to resolve these matters or obtain licenses on acceptable or commercially reasonable terms, we could be sued or we may be forced to initiate litigation to protect our rights. The cost of any necessary licenses could materially adversely affect our business, results of operations and financial condition.

In the event successful claims of infringement are brought by third parties, and we are unable to obtain licenses or independently develop alternative technology on a timely basis, we may be subject to indemnification obligations, be unable to offer competitive products or be subject to increased expenses. If we do not resolve these claims on a favorable basis, our business, results of operations and financial condition could be materially adversely affected.

As part of growing our business, we may make acquisitions. If we fail to successfully select, execute or integrate our acquisitions, then our business, results of operations and financial condition could be materially adversely affected and our stock price could decline.

From time to time, we may undertake acquisitions to add new product and service lines and technologies, acquire talent, gain new sales channels or enter into new sales territories. Acquisitions involve numerous risks and challenges, including relating to the successful integration of the acquired business, entering into new territories or markets with which we have limited or no prior experience, establishing or maintaining business relationships with new retailers, distributors or other channel partners, vendors and suppliers and potential post-closing disputes.

 

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We cannot ensure that we will be successful in selecting, executing and integrating acquisitions. Failure to manage and successfully integrate acquisitions could materially harm our business, financial condition and results of operations. In addition, if stock market analysts or our stockholders do not support or believe in the value of the acquisitions that we choose to undertake, our stock price may decline.

If we do not effectively manage our sales channel inventory and product mix, we may incur costs associated with excess inventory, or lose sales from having too few products.

If we are unable to properly monitor, control and manage our sales channel inventory and maintain an appropriate level and mix of products with our distributors and within our sales channels, we may incur increased and unexpected costs associated with this inventory. We generally allow distributors and traditional retailers to return a limited amount of our products in exchange for other products. Under our price protection policy, if we reduce the list price of a product, we are often required to issue a credit in an amount equal to the reduction for each of the products held in inventory by our wholesale distributors and retailers. If our wholesale distributors and retailers are unable to sell their inventory in a timely manner, we might lower the price of the products, or these parties may exchange the products for newer products. Also, during the transition from an existing product to a new replacement product, we must accurately predict the demand for the existing and the new product.

We determine production levels based on our forecasts of demand for our products. Actual demand for our products depends on many factors, which makes it difficult to forecast. We have experienced differences between our actual and our forecasted demand in the past and expect differences to arise in the future. If we improperly forecast demand for our products, we could end up with too many products and be unable to sell the excess inventory in a timely manner, if at all, or, alternatively, we could end up with too few products and not be able to satisfy demand. This problem is exacerbated because we attempt to closely match inventory levels with product demand, leaving limited margin for error. If these events occur, we could incur increased expenses associated with writing off excessive or obsolete inventory, lose sales, incur penalties for late delivery or have to ship products by air freight to meet immediate demand, thereby incurring incremental freight costs above the sea freight costs, a preferred method, and suffering a corresponding decline in gross margin.

Global economic conditions could materially adversely affect our revenue and results of operations.

Our business has been and may continue to be affected by a number of factors that are beyond our control, such as general geopolitical, economic and business conditions, conditions in the financial markets and changes in the overall demand for connected lifestyle products. Our products and services may be considered discretionary items for our consumer and small business end-users. A severe and/or prolonged economic downturn could adversely affect our customers’ financial condition and the levels of business activity of our customers. Weakness in, and uncertainty about, global economic conditions may cause businesses to postpone spending in response to tighter credit, negative financial news and/or declines in income or asset values, which could have a material negative effect on the demand for our products.

In the recent past, various regions worldwide have experienced slow economic growth. In addition, current economic challenges in China, including any global economic ramifications of these challenges, may continue to put negative pressure on global economic conditions. If conditions in the global economy, including Europe, China, Australia and the United States, or other key vertical or geographic markets deteriorate, such conditions could materially adversely affect our business, results of operations and financial condition. If we are unable to successfully anticipate changing economic and political conditions, we may be unable to effectively plan for and respond to those changes, which could materially adversely affect our business, results of operations and financial condition. In addition, the economic problems affecting the financial markets and the uncertainty in global economic conditions resulted in a number of adverse effects, including a low level of liquidity in many financial markets, extreme volatility in credit, equity, currency and fixed income markets, instability in the stock market and high unemployment.

 

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For example, the challenges faced by the European Union to stabilize some of its member economies, such as Greece, Portugal, Spain, Hungary and Italy, have had international implications affecting the stability of global financial markets and hindering economies worldwide. Many member nations in the European Union have been addressing the issues with controversial austerity measures. In addition, the potential consequences of the “Brexit” process in the United Kingdom have led to significant uncertainty in the region. Should the European Union monetary policy measures be insufficient to restore confidence and stability to the financial markets, or should the United Kingdom’s “Brexit” decision lead to additional economic or political instability, the global economy, including the U.S. and European Union economies where we have a significant presence, could be hindered, which could have a material adverse effect on us. There could also be a number of other follow-on effects from these economic developments on our business, including the inability of customers to obtain credit to finance purchases of our products, customer insolvencies, decreased customer confidence to make purchasing decisions, decreased customer demand and decreased customer ability to pay their trade obligations.

In addition, availability of our products from third-party manufacturers and our ability to distribute our products into non-U.S. jurisdictions may be impacted by factors such as an increase in duties, tariffs or other restrictions on trade; raw material shortages, work stoppages, strikes and political unrest; economic crises and international disputes or conflicts; changes in leadership and the political climate in countries from which we import products; and failure of the United States to maintain normal trade relations with China and other countries. While China currently enjoys “most favored nation” trading status with the United States, the Trump administration has proposed to revoke that status and to impose higher tariffs on products imported from China, which could materially adversely affect our business, results of operations and financial condition.

The success of our business depends on customers’ continued and unimpeded access to our platform on the internet.

Our users must have internet access in order to use our platform. Some providers may take measures that affect their customers’ ability to use our platform, such as degrading the quality of the data packets we transmit over their lines, giving those packets lower priority, giving other packets higher priority than ours, blocking our packets entirely or attempting to charge their customers more for using our platform.

In December 2010, the Federal Communications Commission (the “FCC”), adopted net neutrality rules barring internet providers from blocking or slowing down access to online content, protecting services like ours from such interference. Recently, the FCC voted in favor of repealing the net neutrality rules, and it is currently uncertain how the U.S. Congress will respond to this decision. To the extent network operators attempt to interfere with our services, extract fees from us to deliver our solution or otherwise engage in discriminatory practices, our business, results of operations and financial condition could be materially adversely affected. Within such a regulatory environment, we could experience discriminatory or anti-competitive practices that could impede our domestic and international growth, cause us to incur additional expense or otherwise materially adversely affect our business, results of operations and financial condition.

Changes in tax laws or exposure to additional income tax liabilities could affect our future profitability.

Factors that could materially affect our future effective tax rates include but are not limited to:

 

    changes in tax laws or the regulatory environment;

 

    changes in accounting and tax standards or practices;

 

    changes in the composition of operating income by tax jurisdiction; and

 

    our operating results before taxes.

 

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We are subject to income taxes in the United States and numerous foreign jurisdictions. Because we do not have a long history of operating as a separate company and we have significant expansion plans, our effective tax rate may fluctuate in the future. Future effective tax rates could be affected by operating losses in jurisdictions where no tax benefit can be recorded under GAAP, changes in the composition of earnings in countries with differing tax rates, changes in deferred tax assets and liabilities, or changes in tax laws.

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) was signed into law making significant changes to the Internal Revenue Code of 1986, as amended (the “Code”). In particular, sweeping changes were made to the U.S. taxation of foreign operations. Changes include, but are not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years beginning after December 31, 2017, the transition of U.S. international taxation from a worldwide tax system to a quasi-territorial system, and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings. Additionally, new provisions were added to mitigate the potential erosion of the U.S. tax base and to discourage use of low tax jurisdictions to own intellectual property and other valuable intangible assets. While these provisions were intended to prevent specific perceived taxpayer abuse, they may have adverse, unexpected consequences. At this time, Treasury has not yet issued Regulations on how these new rules should be applied and how the relevant calculations are to be prepared. As there exists only limited guidance at this time, significant estimates and judgment are required in assessing the consequences. The amounts for adjusting the deferred tax assets and liabilities for the new effective tax rate and the transition tax are provisional based on the guidance provided by the SEC in Staff Accounting Bulletin No. 118 (“SAB 118”), which provides for a measurement period of one year from the enactment date to finalize the accounting for effects of the 2017 Tax Act. As a result of continued regulations and interpretations of the Tax Act, we are still quantifying the effects of the tax law change. Based on information available, we also reflected a provisional estimate of $2.9 million related to the transitional tax that was fully offset with tax attributes and therefore did not result in an income tax expense. The amounts reported as of December 31, 2017 are provisional based on the uncertainty discussed above. As we complete our analysis and prepare necessary data, and interpret any additional guidance, we will adjust our calculations and provisional amounts that we have recorded in our tax provision. Any such adjustments may materially impact our provision for income taxes in our financial statements.

In addition to the impact of the Tax Act on our federal taxes, the Tax Act may impact our taxation in other jurisdictions, including with respect to state income taxes. State legislatures have not had sufficient time to respond to the Tax Act. Accordingly, there is uncertainty as to how the laws will apply in the various state jurisdictions. Additionally, other foreign governing bodies may enact changes to their tax laws in reaction to the Tax Act that could result in changes to our global tax position and materially adversely affect our business, results of operations and financial condition.

Additionally, the IRS and several foreign tax authorities have increasingly focused attention on intercompany transfer pricing with respect to sales of products and services and the use of intangibles. Tax authorities could disagree with our intercompany charges, cross-jurisdictional transfer pricing or other matters and assess additional taxes. If we do not prevail in any such disagreements, our profitability may be affected.

We must comply with indirect tax laws in multiple jurisdictions, as well as complex customs duty regimes worldwide. Audits of our compliance with these rules may result in additional liabilities for taxes, duties, interest and penalties related to our international operations which would reduce our profitability.

Our operations are routinely subject to audit by tax authorities in various countries. Many countries have indirect tax systems where the sale and purchase of goods and services are subject to tax based on the transaction value. These taxes are commonly referred to as value-added tax (“VAT”) or goods and services tax (“GST”). In addition, the distribution of our products subjects us to numerous complex customs regulations, which frequently change over time. Failure to comply with these systems and regulations can result in the assessment of additional taxes, duties, interest and penalties. While we believe we are in compliance with local laws, we cannot assure that tax and customs authorities agree with our reporting positions and upon audit may assess us additional taxes, duties, interest and penalties.

 

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Additionally, some of our products are subject to U.S. export controls, including the Export Administration Regulations and economic sanctions administered by the Office of Foreign Assets Control. We also incorporate encryption technology into certain of our solutions. These encryption solutions and underlying technology may be exported outside of the United States only with the required export authorizations or exceptions, including by license, a license exception, appropriate classification notification requirement and encryption authorization.

Furthermore, our activities are subject to U.S. economic sanctions laws and regulations that prohibit the shipment of certain products and services without the required export authorizations, including to countries, governments and persons targeted by U.S. embargoes or sanctions. Additionally, the Trump administration has been critical of existing trade agreements and may impose more stringent export and import controls. Obtaining the necessary export license or other authorization for a particular sale may be time consuming, and may result in delay or loss of sales opportunities even if the export license ultimately is granted. While we take precautions to prevent our solutions from being exported in violation of these laws, including using authorizations or exceptions for our encryption products and implementing IP address blocking and screenings against U.S. government and international lists of restricted and prohibited persons and countries, we have not been able to guarantee, and cannot guarantee that the precautions we take will prevent all violations of export control and sanctions laws, including if purchasers of our products bring our products and services into sanctioned countries without our knowledge. Violations of U.S. sanctions or export control laws can result in significant fines or penalties and incarceration could be imposed on employees and managers for criminal violations of these laws.

Also, various countries, in addition to the United States, regulate the import and export of certain encryption and other technology, including import and export licensing requirements, and have enacted laws that could limit our ability to distribute our products and services or our end-users’ ability to utilize our solutions in their countries. Changes in our products and services or changes in import and export regulations may create delays in the introduction of our products in international markets. Furthermore, recent actions by the Trump administration announcing increased duties on products imported from China may severely impact the price of our goods imported into the United States in the future, and other countries may follow suit and increase duties on goods produced in China.

Adverse action by any government agencies related to indirect tax laws could materially adversely affect our business, results of operations and financial condition.

We are subject to, and must remain in compliance with, numerous laws and governmental regulations concerning the manufacturing, use, distribution and sale of our products, as well as any such future laws and regulations. Some of our customers also require that we comply with their own unique requirements relating to these matters. Any failure to comply with such laws, regulations and requirements, and any associated unanticipated costs, could materially adversely affect our business, results of operations and financial condition.

We manufacture and sell products which contain electronic components, and such components may contain materials that are subject to government regulation in both the locations where we manufacture and assemble our products, as well as the locations where we sell our products. For example, certain regulations limit the use of lead in electronic components. To our knowledge, we maintain compliance with all applicable current government regulations concerning the materials utilized in our products for all the locations in which we operate. Since we operate on a global basis, this is a complex process which requires continual monitoring of regulations and an ongoing compliance process to ensure that we and our suppliers are in compliance with all existing regulations. There are areas where new regulations have been enacted which could increase our cost of the components that we utilize or require us to expend additional resources to ensure compliance. For example, the SEC’s “conflict minerals” rules apply to our business, and we are expending resources to ensure compliance. The implementation of these requirements by government regulators and our partners and/or customers could adversely affect the sourcing, availability and pricing of minerals used in the manufacture of certain components used in our products. In addition, the supply-chain due diligence investigation required by the conflict minerals

 

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rules will require expenditures of resources and management attention regardless of the results of the investigation. If there is an unanticipated new regulation which significantly impacts our use of various components or requires more expensive components, that regulation could materially adversely affect our business, results of operations and financial condition.

One area that has a large number of regulations is environmental compliance. Management of environmental pollution and climate change has produced significant legislative and regulatory efforts on a global basis, and we believe this will continue both in scope and in the number of countries participating. These changes could directly increase the cost of energy, which may have an impact on the way we manufacture products or utilize energy to produce our products. In addition, any new regulations or laws in the environmental area might increase the cost of raw materials we use in our products. Environmental regulations require us to reduce product energy usage, monitor and exclude an expanding list of restricted substances and to participate in required recovery and recycling of our products. While future changes in regulations are certain, we are currently unable to predict how any such changes will impact us and if such impacts will be material to our business. If there is a new law or regulation that significantly increases our costs of manufacturing or causes us to significantly alter the way that we manufacture our products, this could have a material adverse effect on our business, financial condition and results of operations.

Our selling and distribution practices are also regulated in large part by U.S. federal and state as well as foreign antitrust and competition laws and regulations. In general, the objective of these laws is to promote and maintain free competition by prohibiting certain forms of conduct that tend to restrict production, raise prices or otherwise control the market for goods or services to the detriment of consumers of those goods and services. Potentially prohibited activities under these laws may include unilateral conduct or conduct undertaken as the result of an agreement with one or more of our suppliers, competitors or customers. The potential for liability under these laws can be difficult to predict as it often depends on a finding that the challenged conduct resulted in harm to competition, such as higher prices, restricted supply or a reduction in the quality or variety of products available to consumers. We utilize a number of different distribution channels to deliver our products to customers and end-users and regularly enter into agreements with resellers of our products at various levels in the distribution chain that could be subject to scrutiny under these laws in the event of private litigation or an investigation by a governmental competition authority. In addition, many of our products are sold to consumers via the internet. Many of the competition-related laws that govern these internet sales were adopted prior to the advent of the internet and, as a result, do not contemplate or address the unique issues raised by online sales. New interpretations of existing laws and regulations, whether by courts or by the state, federal or foreign governmental authorities charged with the enforcement of those laws and regulations, may also impact our business in ways we are currently unable to predict. Any failure on our part or on the part of our employees, agents, distributors or other business partners to comply with the laws and regulations governing competition can result in negative publicity and diversion of management time and effort and may subject us to significant litigation liabilities and other penalties.

We are exposed to the credit risk of some of our customers and to credit exposures in certain markets, which could result in material losses.

A substantial portion of our sales are on an open credit basis, with typical payment terms of 30 to 60 days in the United States and, because of local customs or conditions, longer in some markets outside the United States. We monitor individual customer financial viability in granting such open credit arrangements, seek to limit such open credit to amounts we believe the customers can pay and maintain reserves we believe are adequate to cover exposure for doubtful accounts.

Any bankruptcies or illiquidity among our customer base could harm our business and have a material adverse effect on our financial condition and results of operations. To the degree that turmoil in the credit markets makes it more difficult for some customers to obtain financing, our customers’ ability to pay could be adversely impacted, which in turn could materially adversely affect our business, results of operations and financial condition.

 

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If our products are not compatible with some or all leading third-party IoT products and protocols, we could be materially adversely affected.

A core part of our solution is the interoperability of our platform with third-party IoT products and protocols. The Arlo platform seamlessly integrates with third-party IoT products and protocols, such as Amazon Alexa, Apple HomeKit, Apple TV, Google Assistant, IFTTT, Stringify and Samsung SmartThings. If these third parties were to alter their products, we could be adversely impacted if we fail to timely create compatible versions of our products, and such incompatibility could negatively impact the adoption of our products and solutions. A lack of interoperability may also result in significant redesign costs, and harm relations with our customers. Further, the mere announcement of an incompatibility problem relating to our products could materially adversely affect our business, results of operations and financial condition.

In addition, to the extent our competitors supply products that compete with our own, it is possible these competitors could design their technologies to be closed or proprietary systems that are incompatible with our products or work less effectively with our products than their own. As a result, end-users may have an incentive to purchase products that are compatible with the products and technologies of our competitors over our products.

The marketability of our products may suffer if wireless telecommunications operators do not deliver acceptable wireless services.

The success of our business depends, in part, on the capacity, affordability, reliability and prevalence of wireless data networks provided by wireless telecommunications operators and on which our IoT hardware products and solutions operate. Growth in demand for wireless data access may be limited if, for example, wireless telecommunications operators cease or materially curtail operations, fail to offer services that customers consider valuable at acceptable prices, fail to maintain sufficient capacity to meet demand for wireless data access, delay the expansion of their wireless networks and services, fail to offer and maintain reliable wireless network services or fail to market their services effectively.

We are exposed to adverse currency exchange rate fluctuations in jurisdictions where we transact in local currency, which could materially adversely affect our business, results of operations and financial condition.

Because a significant portion of our business is conducted outside the United States, we face exposure to adverse movements in foreign currency exchange rates. These exposures may change over time as business practices evolve, and they could have a material adverse impact on our financial condition, results of operations and cash flows. Although a portion of our international sales are currently invoiced in U.S. dollars, we have implemented and continue to implement for certain countries and customers both invoicing and payment in foreign currencies. Our primary exposure to movements in foreign currency exchange rates relates to non-U.S. dollar-denominated sales primarily in Europe and Australia, as well as our global operations, and non-U.S. dollar-denominated operating expenses and certain assets and liabilities. In addition, weaknesses in foreign currencies for U.S. dollar-denominated sales could adversely affect demand for our products. Conversely, a strengthening in foreign currencies against the U.S. dollar could increase foreign currency-denominated costs. As a result, we may attempt to renegotiate pricing of existing contracts or request payment to be made in U.S. dollars. We cannot be sure that our customers would agree to renegotiate along these lines. This could result in customers eventually terminating contracts with us or in our decision to terminate certain contracts, which would adversely affect our sales.

We plan to establish a hedging program after the distribution, if not before, to hedge our exposure to fluctuations in foreign currency exchange rates as a response to the risk of changes in the value of foreign currency-denominated assets and liabilities. We may enter into foreign currency forward contracts or other instruments. We expect that such foreign currency forward contracts will reduce, but will not eliminate, the

 

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impact of currency exchange rate movements. For example, we may not execute forward contracts in all currencies in which we conduct business. In addition, we may hedge to reduce the impact of volatile exchange rates on revenue, gross profit and operating profit for limited periods of time. However, the use of these hedging activities may only offset a portion of the adverse financial effect resulting from unfavorable movements in foreign exchange rates.

Risks Related to Our Separation from NETGEAR

The distribution may not occur, and the separation may not be successful.

Upon completion of this offering, we will be a stand-alone public company, although we will continue to be controlled by NETGEAR. NETGEAR has informed us that, at some time in the future, but no earlier than the expiration or earlier termination of the 145-day lock-up period applicable to NETGEAR described under the section titled “Underwriting,” it intends to effect the distribution. However, NETGEAR may abandon or change the structure of the distribution if it determines, in its sole discretion, that the distribution is not in the best interest of NETGEAR or its stockholders.

In addition, the process of becoming a stand-alone public company may distract our management from focusing on our business and strategic priorities. Further, although we expect to have direct access to the debt and equity capital markets following this offering, we may not be able to issue debt or equity on terms acceptable to us or at all. Moreover, even with equity compensation tied to our business, we may not be able to attract and retain employees as desired.

We also may not fully realize the intended benefits of being a stand-alone public company if any of the risks identified in this “Risk Factors” section, or other events, were to occur. These intended benefits include improving the strategic and operational flexibility of both companies, increasing the focus of the management teams on their respective business operations, allowing each company to adopt the capital structure, investment policy and dividend policy best suited to its financial profile and business needs, and providing each company with its own equity currency to facilitate acquisitions and to better incentivize management. See the section titled “Certain Relationships and Related Party Transactions—Relationship with NETGEAR.” If we do not realize these intended benefits for any reason, our business may be negatively affected. In addition, the separation could materially adversely affect our business, results of operations and financial condition.

As long as NETGEAR controls us, your ability to influence matters requiring stockholder approval will be limited.

After this offering, NETGEAR will own 62,500,000 shares of our common stock, representing approximately 86.0% of the outstanding shares of our common stock (or approximately 84.2% if the underwriters exercise their option to purchase additional shares in full). For so long as NETGEAR beneficially owns shares of our outstanding common stock representing at least a majority of the votes entitled to be cast by the holders of our outstanding common stock, NETGEAR will be able to elect all of the members of our board of directors. We anticipate that, at the completion of this offering, Mr. Lo will continue to serve as the Chairman of the board of directors and Chief Executive Officer of NETGEAR. See the section titled “Directors.”

NETGEAR’s ability to control our board of directors may make it difficult for us to recruit high-quality independent directors.

So long as NETGEAR beneficially owns shares of our outstanding common stock representing at least a majority of the votes entitled to be cast by the holders of our outstanding voting stock, NETGEAR can effectively control and direct our board of directors.

We anticipate that, at the completion of this offering, Mr. Lo will continue to serve as the Chairman of the board of directors and Chief Executive Officer of NETGEAR. Further, the interests of NETGEAR and our

 

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other stockholders may diverge. Under these circumstances, persons who might otherwise accept our invitation to join our board of directors may decline.

NETGEAR’s interests may conflict with our interests and the interests of our other stockholders. Conflicts of interest between us and NETGEAR could be resolved in a manner unfavorable to us and our other stockholders.

Various conflicts of interest between us and NETGEAR could arise. We anticipate that, at the completion of this offering, Mr. Lo will continue to serve as the Chairman of the board of directors and Chief Executive Officer of NETGEAR. Ownership interests of Mr. Lo and NETGEAR in our capital stock and ownership interests of our directors and officers in NETGEAR capital stock, or service by an individual as either a director and/or officer of both companies, could create or appear to create potential conflicts of interest when such individuals are faced with decisions relating to us. These decisions could include:

 

    corporate opportunities;

 

    the impact that operating or capital decisions (including the incurrence of indebtedness) relating to our business may have on NETGEAR’s consolidated financial statements and/or current or future indebtedness (including related covenants);

 

    business combinations involving us;

 

    our dividend and stock repurchase policies;

 

    compensation and benefit programs and other human resources policy decisions;

 

    management stock ownership;

 

    the intercompany agreements and services between us and NETGEAR, including the agreements relating to our separation from NETGEAR;

 

    the payment of dividends on our common stock; and

 

    determinations with respect to our tax returns.

Potential conflicts of interest could also arise if we decide to enter into new commercial arrangements with NETGEAR in the future or in connection with NETGEAR’s desire to enter into new commercial arrangements with third parties. Additionally, NETGEAR may be constrained by the terms of agreements relating to its indebtedness from taking actions, or permitting us to take actions, that may be in our best interest.

Our amended and restated certificate of incorporation will provide that, except as otherwise agreed to in writing by NETGEAR and us, NETGEAR will have no duty to refrain from engaging in the same or similar business activities or lines of business, doing business with any of our customers or employing or otherwise engaging or soliciting for employment any of our directors, officers or employees.

Our amended and restated certificate of incorporation will also provide that in the event that a director or officer of the Company who is also a director or officer of NETGEAR acquires knowledge of a potential corporate opportunity that may be a corporate opportunity for both the Company and NETGEAR (excluding any corporate opportunity that was presented or became known to such director or officer solely in his or her capacity as a director or officer of the Company, as reasonably determined by such director or officer, unless the Company notifies such person that the Company does not intend to pursue such opportunity), such director or officer may present such opportunity to the Company or NETGEAR or both, as such director or officer

 

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determines in his or her sole discretion, and that by doing so such person will have satisfied his or her duties to the Company and its stockholders. Our amended and restated certificate of incorporation will provide that we renounce any interest in any such opportunity presented to NETGEAR. These provisions create the possibility that a corporate opportunity of the Company may be used for the benefit of NETGEAR. However, the corporate opportunity provisions in our amended and restated certificate of incorporation will cease to apply and will have no further force and effect from and after the date that both (1) NETGEAR ceases to own shares of our common stock representing at least 50% of the total voting power of our common stock and (2) no person who is a director or officer of the Company is also a director or officer of NETGEAR.

Furthermore, disputes may arise between us and NETGEAR relating to our past and ongoing relationships, and these potential conflicts of interest may make it more difficult for us to favorably resolve such disputes, including those related to:

 

    tax, employee benefit, indemnification and other matters arising from the separation;

 

    the nature, quality and pricing of services NETGEAR agrees to provide to us; and

 

    sales and other disposals by NETGEAR of all or a portion of its ownership interest in us.

We will have a general policy that all material transactions with a related party, as well as all material transactions in which there is an actual, or in some cases, perceived, conflict of interest, will be subject to prior review and approval by our Audit Committee and its independent members, who will determine whether such transactions or proposals are fair and reasonable to Arlo and its stockholders. In general, potential related-party transactions will be identified by our management and discussed with our Audit Committee at its meetings.

However, we may not be able to resolve any potential conflicts, and even if we do, the resolution may be less favorable to us than if we were dealing with an unaffiliated third party. While we are controlled by NETGEAR, we may not have the leverage to negotiate amendments to our various agreements with NETGEAR (if any are required) on terms as favorable to us as those we would negotiate with an unaffiliated third party.

The terms of the agreements that we expect to enter into with NETGEAR in connection with the separation may limit our ability to take certain actions, including between the completion of this offering and the distribution, which may prevent us from pursuing opportunities to raise capital, acquire other businesses or provide equity incentives to our employees, which could impair our ability to grow.

The terms of the agreements that we expect to enter into with NETGEAR in connection with the separation, including the master separation agreement, may limit our ability to take certain actions, which could impair our ability to grow. The master separation agreement will provide that, as long as NETGEAR beneficially owns at least 50% of the total voting power of our outstanding capital stock entitled to vote in the election of our board of directors, we will not (without NETGEAR’s prior written consent) take certain actions, such as incurring additional indebtedness and acquiring businesses or assets or disposing of assets in excess of certain amounts. In addition, under current tax law, NETGEAR must retain beneficial ownership of at least 80% of our combined voting power and 80% of each class of nonvoting capital stock, if any is outstanding, until immediately prior to the distribution of our stock then held by NETGEAR to its stockholders in order for such distribution to qualify as a transaction that is generally tax-free for U.S. federal income tax purposes. NETGEAR has informed us that, at some time in the future, but no earlier than the expiration or earlier termination of the 145-day lock-up period applicable to NETGEAR described under the section titled “Underwriting,” it intends to effect the distribution. This may result in NETGEAR not supporting transactions that we wish to pursue that involve issuing shares of our capital stock, including for capital-raising purposes, as consideration for an acquisition or as equity incentives to our employees. To preserve the tax-free treatment of the separation and distribution, the master separation agreement will include certain covenants and restrictions to ensure that, until immediately prior to the distribution, NETGEAR will retain beneficial ownership of at least 80% of our

 

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combined voting power and 80% of each class of nonvoting capital stock, if any is outstanding. In addition, to preserve the tax-free treatment of the separation and distribution, we will agree in the tax matters agreement to restrictions, including restrictions that would be effective during the period following the distribution, that could limit our ability to pursue certain strategic transactions, equity issuances or repurchases or other transactions that we may believe to be in the best interests of our stockholders or that might increase the value of our business. See “—We may not be able to engage in desirable strategic or capital-raising transactions following the distribution.” Our inability to pursue such transactions could materially adversely affect our business, results of operations and financial condition.

If the distribution, together with certain related transactions, does not qualify as a transaction that is generally tax-free for U.S. federal income tax purposes, NETGEAR, Arlo and Arlo stockholders could be subject to significant tax liabilities, and, in certain circumstances, we could be required to indemnify NETGEAR for material taxes and other related amounts pursuant to indemnification obligations under the tax matters agreement.

NETGEAR expects to obtain an opinion of counsel regarding qualification of the distribution, together with certain related transactions, as a transaction that is generally tax-free for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) of the Code. The opinion of counsel would be based upon and rely on, among other things, certain facts and assumptions, as well as certain representations, statements and undertakings of NETGEAR and us, including those relating to the past and future conduct of NETGEAR and us. If any of these representations, statements or undertakings are, or become, incomplete or inaccurate, or if we or NETGEAR breach any of the respective covenants in any of the separation-related agreements, the opinion of counsel could be invalid and the conclusions reached therein could be jeopardized.

Notwithstanding any opinion of counsel, the Internal Revenue Service (the “IRS”) could determine that the distribution, together with certain related transactions, should be treated as a taxable transaction if it were to determine that any of the facts, assumptions, representations, statements or undertakings upon which any opinion of counsel was based were false or had been violated, or if it were to disagree with the conclusions in any opinion of counsel. Any opinion of counsel would not be binding on the IRS or the courts, and we cannot assure that the IRS or a court would not assert a contrary position. NETGEAR has not requested, and does not intend to request, a ruling from the IRS with respect to the treatment of the distribution or certain related transactions for U.S. federal income tax purposes.

If the distribution, together with certain related transactions, were to fail to qualify as a transaction that is generally tax-free for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) of the Code, in general, NETGEAR would recognize taxable gain as if it had sold our common stock in a taxable sale for its fair market value, and NETGEAR stockholders who receive shares of our common stock in the distribution would be subject to tax as if they had received a taxable distribution equal to the fair market value of such shares.

We will agree in the tax matters agreement to indemnify NETGEAR for any taxes (and any related costs and other damages) resulting from the separation and distribution, and certain other related transactions, to the extent such amounts were to result from (i) an acquisition after the distribution of all or a portion of our equity securities, whether by merger or otherwise (and regardless of whether we participated in or otherwise facilitated the acquisition), (ii) other actions or failures to act by us or (iii) any of the representations or undertakings contained in any of the separation-related agreements or in the documents relating to the opinion of counsel being incorrect or violated. Any such indemnity obligations could be material.

We may not be able to engage in desirable strategic or capital-raising transactions following the distribution.

Under current law, a distribution that would otherwise qualify as a tax-free transaction, for U.S. federal income tax purposes, under Section 355 of the Code can be rendered taxable to the parent corporation and its

 

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stockholders as a result of certain post-distribution acquisitions of shares or assets of the distributed corporation. For example, such a distribution could result in taxable gain to the parent corporation under Section 355(e) of the Code if the distribution were later deemed to be part of a plan (or series of related transactions) pursuant to which one or more persons acquired, directly or indirectly, shares representing a 50% or greater interest (by vote or value) in the distributed corporation.

To preserve the tax-free treatment of the separation and distribution, and in addition to our expected indemnity obligation described above, we will agree in the tax matters agreement to restrictions that address compliance with Section 355 of the Code (including Section 355(e) of the Code). These restrictions could limit our ability to pursue certain strategic transactions, equity issuances or repurchases or other transactions that we may believe to be in the best interests of our stockholders or that might increase the value of our business.

We have no operating history as a stand-alone public company, and our historical and pro forma financial information is not necessarily representative of the results we would have achieved as a stand-alone public company and may not be a reliable indicator of our future results.

The historical financial information we have included in this prospectus does not reflect, and the pro forma financial information included in this prospectus may not reflect, what our financial condition, results of operations or cash flows would have been had we been a stand-alone entity during the historical periods presented, or what our financial condition, results of operations or cash flows will be in the future as an independent entity.

The pro forma condensed combined financial information included in this prospectus includes adjustments based upon available information we believe to be reasonable. However, the assumptions may change and actual results may differ. In addition, we have not made pro forma adjustments to reflect many significant changes that will occur in our cost structure, funding and operations as a result of our transition to becoming a public company, including changes in our employee base, potential increased costs associated with reduced economies of scale and increased costs associated with being a publicly traded, stand-alone company. For additional information about the basis of presentation of our pro forma financial information and historical financial information included in this prospectus, see the sections titled “Selected Combined Financial Data” and “Unaudited Pro Forma Condensed Combined Financial Statements.”

If NETGEAR experiences a change in control, our current plans and strategies could be subject to change.

As long as NETGEAR controls us, it will have significant influence over our plans and strategies, including strategies relating to marketing and growth. In the event NETGEAR experiences a change in control, a new NETGEAR owner may attempt to cause us to revise or change our plans and strategies, as well as the agreements between NETGEAR and us, described in this prospectus. A new owner may also have different plans with respect to the contemplated distribution of our common stock to NETGEAR stockholders, including not effecting such a distribution.

The assets and resources that we acquire from NETGEAR in the separation may not be sufficient for us to operate as a stand-alone company, and we may experience difficulty in separating our assets and resources from NETGEAR.

Because we have not operated as an independent company in the past, we will need to acquire assets in addition to those contributed by NETGEAR and its subsidiaries to us and our subsidiaries in connection with our separation from NETGEAR. We may also face difficulty in separating our assets from NETGEAR’s assets and integrating newly acquired assets into our business. Our business, financial condition and results of operations could be harmed if we fail to acquire assets that prove to be important to our operations or if we incur unexpected costs in separating our assets from NETGEAR’s assets or integrating newly acquired assets.

 

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The services that NETGEAR provides to us may not be sufficient to meet our needs, which may result in increased costs and otherwise adversely affect our business.

Pursuant to the transition services agreement, we expect NETGEAR to continue to provide us with corporate and shared services for a transitional period related to corporate functions, such as executive oversight, risk management, information technology, accounting, audit, legal, investor relations, tax, treasury, shared facilities, engineering, operations, customer support, human resources and employee benefits, sales and sales operations and other services in exchange for the fees specified in the transition services agreement between us and NETGEAR. NETGEAR will not be obligated to provide these services in a manner that differs from the nature of the services provided to the Arlo business during the 12-month period prior to the separation, and thus we may not be able to modify these services in a manner desirable to us as a stand-alone public company. Further, if we no longer receive these services from NETGEAR due to the termination of the transition services agreement or otherwise, we may not be able to perform these services ourselves and/or find appropriate third party arrangements at a reasonable cost (and any such costs may be higher than those charged by NETGEAR). See the section titled “Certain Relationships and Related Party Transactions—Relationship with NETGEAR.”

Our ability to operate our business effectively may suffer if we are unable to cost-effectively establish our own administrative and other support functions in order to operate as a stand-alone company after the expiration of our shared services and other intercompany agreements with NETGEAR.

As an operating segment of NETGEAR, we relied on administrative and other resources of NETGEAR, including information technology, accounting, finance, human resources and legal services, to operate our business. In connection with this offering, we have entered into various service agreements to retain the ability for specified periods to use these NETGEAR resources. See the section titled “Certain Relationships and Related Party Transactions.” These services may not be provided at the same level as when we were a business segment within NETGEAR, and we may not be able to obtain the same benefits that we received prior to this offering. These services may not be sufficient to meet our needs, and after our agreements with NETGEAR expire (which will generally occur within 18 months following the completion of this offering), we may not be able to replace these services at all or obtain these services at prices and on terms as favorable as we currently have with NETGEAR. We will need to create our own administrative and other support systems or contract with third parties to replace NETGEAR’s systems. In addition, we have received informal support from NETGEAR, which may not be addressed in the agreements we have entered into with NETGEAR, and the level of this informal support may diminish as we become a more independent company. Any failure or significant downtime in our own administrative systems or in NETGEAR’s administrative systems during the transitional period could result in unexpected costs, impact our results and/or prevent us from paying our suppliers or employees and performing other administrative services on a timely basis.

After this offering, we will be a smaller company relative to NETGEAR, which could result in increased costs in our supply chain and in general because of a decrease in our purchasing power. We may also experience decreased revenue due to difficulty maintaining existing customer relationships and obtaining new customers.

Prior to this offering, we were able to take advantage of NETGEAR’s size and purchasing power in procuring goods, technology and services, including insurance, employee benefit support and audit and other professional services. In addition, as a segment of NETGEAR, we were able to leverage NETGEAR’s size and purchasing power to bargain with suppliers of our components and our ODMs. We are a smaller company than NETGEAR, and we cannot assure you that we will have access to financial and other resources comparable to those available to us prior to this offering. As a stand-alone company, we may be unable to obtain office space, goods, technology and services in general, as well as components and services that are part of our supply chain, at prices or on terms as favorable as those available to us prior to this offering, which could increase our costs and reduce our profitability. Our future success depends on our ability to maintain our current relationships with existing customers, and we may have difficulty attracting new customers.

 

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NETGEAR has agreed to indemnify us for certain liabilities. However, we cannot assure that the indemnity will be sufficient to insure us against the full amount of such liabilities, or that NETGEAR’s ability to satisfy its indemnification obligation will not be impaired in the future.

Pursuant to the master separation agreement and certain other agreements with NETGEAR, NETGEAR has agreed to indemnify us for certain liabilities. The master separation agreement will provide for cross-indemnities principally designed to place financial responsibility for the obligations and liabilities of our business with us and financial responsibility for the obligations and liabilities of NETGEAR’s business with NETGEAR. See the section titled “Certain Relationships and Related Party Transactions—Master Separation Agreement—Indemnification.” We anticipate that, under the intellectual property rights cross-license agreement to be entered into between us and NETGEAR prior to the completion of this offering, each party, in its capacity as a licensee, will indemnify the other party, in its capacity as a licensor, and its directors, officers, agents, successors and subsidiaries against any losses suffered by such indemnified party as a result of the indemnifying party’s practice of the intellectual property licensed to such indemnifying party under the intellectual property rights cross-license agreement. See the section titled “Certain Relationships and Related Party Transactions—Intellectual Property Rights Cross-License Agreement.” We also anticipate that, under the tax matters agreement to be entered into between us and NETGEAR prior to the completion of this offering, each party will be liable for, and indemnify the other party and its subsidiaries from and against any liability for, taxes that are allocated to the indemnifying party under the tax matters agreement. In addition, we will agree in the tax matters agreement that each party will generally be responsible for any taxes and related amounts imposed on us or NETGEAR as a result of the failure of the distribution, together with certain related transactions, to qualify as a transaction that is generally tax-free, for U.S. federal income tax purposes, under Sections 355 and 368(a)(1)(D) and certain other relevant provisions of the Code, to the extent that the failure to so qualify is attributable to actions, events or transactions relating to such party’s respective stock, assets or business, or a breach of the relevant representations or covenants made by that party in the tax matters agreement. See the section titled “Certain Relationships and Related Party Transactions—Tax Matters Agreement.” The transition services agreement will generally provide that the applicable service recipient indemnifies the applicable service provider for liabilities that such service provider incurs arising from the provision of services other than liabilities arising from such service provider’s gross negligence, bad faith or willful misconduct or material breach of the transition services agreement, and that the applicable service provider indemnifies the applicable service recipient for liabilities that such service recipient incurs arising from such service provider’s gross negligence, bad faith or willful misconduct or material breach of the transition services agreement. See the section titled “Certain Relationships and Related Party Transactions—Transition Services Agreement.” Pursuant to the registration rights agreement, we will agree to indemnify NETGEAR and its subsidiaries that hold registrable securities (and their directors, officers, agents and, if applicable, each other person who controls such holder under Section 15 of the Securities Act of 1933, as amended (the “Securities Act”)) registering shares pursuant to the registration rights agreement against certain losses, expenses and liabilities under the Securities Act, common law or otherwise. NETGEAR and its subsidiaries that hold registrable securities will similarly idemnify us but such indemnification will be limited to an amount equal to the net proceeds received by such holder under the sale of registrable securities giving rise to the indemnification obligation. See the section titled “Certain Relationships and Related Party Transactions—Registration Rights Agreement.”

However, third parties could also seek to hold us responsible for any of the liabilities that NETGEAR has agreed to retain, and we cannot assure that an indemnity from NETGEAR will be sufficient to protect us against the full amount of such liabilities, or that NETGEAR will be able to fully satisfy its indemnification obligations in the future. Even if we ultimately succeed in recovering from NETGEAR any amounts for which we are held liable, we may be temporarily required to bear these losses. Each of these risks could materially adversely affect our business, results of operations and financial condition.

 

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Certain contracts used in our business will need to be replaced, or assigned from NETGEAR or its affiliates to Arlo in connection with the separation, which may require the consent of the counterparty to such an assignment, and failure to obtain such replacement contracts or consents could increase Arlo’s expenses or otherwise adversely affect our results of operations.

Our separation from NETGEAR requires us to replace shared contracts and, with respect to certain contracts that are to be assigned from NETGEAR or its affiliates to us or our affiliates, to obtain consents and assignments from third parties. It is possible that, in connection with the replacement or consent process, some parties may seek more favorable contractual terms from Arlo. If we are unable to obtain such replacement contracts or consents, as applicable, we may be unable to obtain some of the benefits, assets and contractual commitments that are intended to be allocated to Arlo as part of the separation. If Arlo is unable to obtain such replacement contracts or consents, the loss of these contracts could increase Arlo’s expenses or otherwise materially adversely affect our business, results of operations and financial condition.

Some of our directors and executive officers own NETGEAR common stock, restricted shares of NETGEAR common stock or options to acquire NETGEAR common stock and hold positions with NETGEAR, which could cause conflicts of interest, or the appearance of conflicts of interest, that result in our not acting on opportunities we otherwise may have.

Some of our directors and executive officers own NETGEAR common stock, restricted shares of NETGEAR stock or options to purchase NETGEAR common stock. In addition, we anticipate that, at the completion of this offering, Mr. Lo will continue to serve as the Chairman of the board of directors and Chief Executive Officer of NETGEAR.

Ownership of NETGEAR common stock, restricted shares of NETGEAR common stock and options to purchase NETGEAR common stock by our directors and executive officers after this offering and the presence of executive officers or directors of NETGEAR on our board of directors could create, or appear to create, conflicts of interest with respect to matters involving both us and NETGEAR that could have different implications for NETGEAR than they do for us. For example, potential conflicts of interest could arise in connection with the resolution of any dispute between NETGEAR and us regarding terms of the agreements governing the separation and the relationship between NETGEAR and us thereafter, including the master separation agreement, the employee matters agreement, the tax matters agreement or the transition services agreement. Potential conflicts of interest could also arise if we enter into commercial arrangements with NETGEAR in the future. As a result of these actual or apparent conflicts of interest, we may be precluded from pursuing certain growth initiatives.

We may have received better terms from unaffiliated third parties than the terms we will receive in the agreements that we expect to enter into with NETGEAR.

The agreements that we expect to enter into with NETGEAR in connection with the separation, including the master separation agreement, the transition services agreement, the intellectual property cross-license agreement, the tax matters agreement, the employee matters agreement and the registration rights agreement with respect to NETGEAR’s continuing ownership of our common stock, were prepared in the context of the separation while we were still a wholly owned subsidiary of NETGEAR. See the section titled “Certain Relationships and Related Party Transactions—Relationship with NETGEAR.” Accordingly, during the period in which the terms of those agreements were prepared, we did not have an independent board of directors or a management team that was independent of NETGEAR. As a result, the terms of those agreements may not reflect terms that would have resulted from arm’s-length negotiations between unaffiliated third parties.

 

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Risks Related to This Offering and Ownership of Our Common Stock

No market currently exists for our common stock. We cannot assure you that an active trading market will develop for our common stock.

Prior to this offering, there has been no public market for shares of our common stock. We cannot predict the extent to which investor interest in us will lead to the development of a trading market on the NYSE or otherwise, or how liquid that market might become. If an active market does not develop, you may have difficulty selling any shares of our common stock that you purchase in this offering. The initial public offering price for the shares of our common stock will be determined by negotiations between us and the representatives of the underwriters, and may not be indicative of prices that will prevail in the open market following this offering.

If our stock price fluctuates after this offering, you could lose a significant part of your investment.

The market price of our common stock will be influenced by many factors, some of which are beyond our control, including those described above in “—Risks Related to Our Business” and the following:

 

    the failure of securities analysts to cover our common stock after this offering or changes in financial estimates by analysts;

 

    the inability to meet the financial estimates of securities analysts who follow our common stock or changes in earnings estimates by analysts;

 

    strategic actions by us or our competitors;

 

    announcements by us or our competitors of significant contracts, acquisitions, joint marketing relationships, joint ventures or capital commitments;

 

    our quarterly or annual earnings, or those of other companies in our industry;

 

    actual or anticipated fluctuations in our operating results and those of our competitors;

 

    general economic and stock market conditions;

 

    the public reaction to our press releases, our other public announcements and our filings with the SEC;

 

    risks related to our business and our industry, including those discussed above;

 

    changes in conditions or trends in our industry, markets or customers;

 

    the trading volume of our common stock;

 

    future sales of our common stock or other securities;

 

    whether, when and in what manner NETGEAR completes the distribution; and

 

    investor perceptions of the investment opportunity associated with our common stock relative to other investment alternatives.

In particular, the realization of any of the risks described in these “Risk Factors” could have a material adverse impact on the market price of our common stock in the future and cause the value of your investment to

 

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decline. In addition, the stock market in general has experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market and industry factors may materially reduce the market price of our common stock, regardless of our operating performance. In addition, price volatility may be greater if the public float and trading volume of our common stock is low.

We may change our dividend policy at any time.

Although following this offering we currently intend to retain future earnings to finance the operation and expansion of our business and therefore do not anticipate paying cash dividends on our capital stock in the foreseeable future, our dividend policy may change at any time without notice to our stockholders. The declaration and amount of any future dividends to holders of our common stock will be at the discretion of our board of directors in accordance with applicable law and after taking into account various factors, including our financial condition, results of operations, current and anticipated cash needs, cash flows, impact on our effective tax rate, indebtedness, contractual obligations, legal requirements and other factors that our board of directors deems relevant. As a result, we cannot assure you that we will pay dividends at any rate or at all.

Future sales, or the perception of future sales, of our common stock, including by NETGEAR, may depress the price of our common stock.

The market price of our common stock could decline significantly as a result of sales or other distributions of a large number of shares of our common stock in the market after this offering, including shares that might be offered for sale or distributed by NETGEAR. The perception that these sales might occur could depress the market price of our common stock. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.

Upon completion of this offering, we will have 72,715,000 shares of common stock (74,247,250 shares if the underwriters exercise their option to purchase additional shares in full) outstanding. The shares of common stock offered in this offering will be freely tradable without restriction under the Securities Act, except for any shares of common stock that may be held or acquired by our directors, executive officers and other affiliates, as that term is defined in the Securities Act, which will be restricted securities under the Securities Act. Restricted securities may not be sold in the public market unless the sale is registered under the Securities Act or an exemption from registration is available. We will grant registration rights to NETGEAR with respect to shares of our common stock. Any shares registered pursuant to the registration rights agreement described in the section titled “Certain Relationships and Related Party Transactions” will be freely tradable in the public market following a 145-day lock-up period applicable to NETGEAR as described below.

In connection with this offering, we, our directors and executive officers and NETGEAR have each agreed to enter into a lock-up agreement and thereby be subject to a “lock-up period,” meaning that they and their permitted transferees will not be permitted to sell any of the shares of our common stock for 145 days, in the case of NETGEAR, and for 180 days, in our case and the case of our directors and executive officers, after the date of this prospectus, without the prior consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated and Deutsche Bank Securities Inc. on behalf of the underwriters. Merrill Lynch, Pierce, Fenner & Smith Incorporated and Deutsche Bank Securities Inc., on behalf of the underwriters may, in their sole discretion and without notice, release all or any portion of the shares of our common stock from the restrictions in any of the lock-up agreements described above. See the section titled “Underwriting.”

Also, in the future, we may issue our securities in connection with investments or acquisitions. The amount of shares of our common stock issued in connection with an investment or acquisition could constitute a material portion of our then-outstanding shares of our common stock.

 

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You may experience immediate and substantial dilution in the net tangible book value of the shares you purchase in this offering, and you will suffer additional dilution if the underwriters exercise their option to purchase additional shares.

If you purchase shares of our common stock in this offering, you will experience immediate and substantial dilution, as the initial public offering price of our common stock will be substantially greater than the pro forma net tangible book value per share of our common stock. Based on the assumed initial offering price of $19.00 per share, if you purchase our common stock in this offering, you will suffer immediate and substantial dilution of $15.36 per share. In addition, in connection with this offering, we expect to grant our executive officers, non-employee directors and employees certain stock-based compensation awards as described under “—Compensatory Arrangements for Certain Executive Officers—IPO Grants” and “—Compensatory Arrangements for Certain Executive Officers—Additional Grants of Arlo Equity Awards Prior to the Offering.” Further, in connection with the distribution, we expect that NETGEAR stock-based compensation awards held by our employees and NETGEAR employees will be adjusted as described under “Certain Relationships and Related Party Transactions—Employee Matters Agreement” below, which may result in additional dilution to investors.

Our costs will increase significantly as a result of operating as a public company, and our management will be required to devote substantial time to complying with public company regulations.

We have historically operated our business as a segment of a public company. As a stand-alone public company, we will have additional legal, accounting, insurance, compliance and other expenses that we have not incurred historically. After this offering, we will become obligated to file with the SEC annual and quarterly reports and other reports that are specified in Section 13 and other sections of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We will also be required to ensure that we have the ability to prepare financial statements that are fully compliant with all SEC reporting requirements on a timely basis. In addition, we will become subject to other reporting and corporate governance requirements, including certain requirements of the NYSE, and certain provisions of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) and the regulations promulgated thereunder, which will impose significant compliance obligations upon us.

Sarbanes-Oxley, as well as rules subsequently implemented by the SEC and the NYSE, have imposed increased regulation and disclosure and required enhanced corporate governance practices of public companies. We are committed to maintaining high standards of corporate governance and public disclosure, and our efforts to comply with evolving laws, regulations and standards in this regard are likely to result in increased selling and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. These changes will require a significant commitment of additional resources. We may not be successful in implementing these requirements and implementing them could materially adversely affect our business, results of operations and financial condition. In addition, if we fail to implement the requirements with respect to our internal accounting and audit functions, our ability to report our operating results on a timely and accurate basis could be impaired. If we do not implement such requirements in a timely manner or with adequate compliance, we might be subject to sanctions or investigation by regulatory authorities, such as the SEC and the NYSE. Any such action could harm our reputation and the confidence of investors and customers in us and could materially adversely affect our business and cause our share price to fall.

Failure to achieve and maintain effective internal controls in accordance with Section 404 of Sarbanes-Oxley could materially adversely affect our business, results of operations, financial condition and stock price.

As a public company, we will be required to document and test our internal control procedures in order to satisfy the requirements of Section 404 of Sarbanes-Oxley (“Section 404”), which will require annual management assessments of the effectiveness of our internal control over financial reporting. Upon loss of emerging growth company status, an annual report by our independent registered public accounting firm that addresses the effectiveness of internal control over financial reporting will be required. During the course of our testing, we may identify deficiencies which we may not be able to remediate in time to meet our deadline for compliance with Section 404. Testing and maintaining internal control can divert our management’s attention from other matters that are important to the operation of our business. We also expect the regulations under

 

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Sarbanes-Oxley to increase our legal and financial compliance costs, make it more difficult to attract and retain qualified officers and members of our board of directors, particularly to serve on our audit committee, and make some activities more difficult, time consuming and costly. We may not be able to conclude on an ongoing basis that we have effective internal control over our financial reporting in accordance with Section 404 or our independent registered public accounting firm may not be able or willing to issue an unqualified report on the effectiveness of our internal control over financial reporting. If we conclude that our internal control over financial reporting is not effective, we cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or their effect on our operations because there is presently no precedent available by which to measure compliance adequacy. If either we are unable to conclude that we have effective internal control over our financial reporting or our independent auditors are unable to provide us with an unqualified report as required by Section 404, then investors could lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock.

If securities or industry analysts do not publish research or reports about our business, if they adversely change their recommendations regarding our stock or if our operating results do not meet their expectations, our stock price could decline.

The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of these analysts cease coverage of us or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline. Moreover, if one or more of the analysts who cover us downgrades our stock or if our operating results do not meet their expectations, our stock price could decline.

We could be subject to securities class action litigation.

In the past, securities class action litigation has often been instituted against companies whose securities have experienced periods of volatility in market price. Securities litigation brought against us following volatility in the price of our common stock, regardless of the merit or ultimate results of such litigation, could result in substantial costs, which would hurt our financial condition and results of operations and divert management’s attention and resources from our business.

Your percentage ownership in Arlo may be diluted in the future.

In the future, your percentage ownership in Arlo may be diluted because of equity awards that Arlo will be granting to Arlo’s directors, officers and employees or otherwise as a result of equity issuances for acquisitions or capital market transactions. In connection with and following this offering, Arlo anticipates that it will grant equity awards to its employees. In addition, following the distribution, Arlo and NETGEAR employees will hold awards in respect of shares of our common stock as a result of the conversion of their NETGEAR stock awards (in whole or in part) to Arlo stock awards in connection with the distribution. Such awards will have a dilutive effect on Arlo’s earnings per share, which could adversely affect the market price of Arlo common stock. From time to time, Arlo will issue additional stock-based awards to its employees under Arlo’s employee benefits plans.

In addition, Arlo’s amended and restated certificate of incorporation will authorize Arlo to issue, without the approval of Arlo’s stockholders, one or more classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over Arlo’s common stock respecting dividends and distributions, as Arlo’s board of directors generally may determine. The terms of one or more classes or series of preferred stock could dilute the voting power or reduce the value of our common stock. For example, Arlo could grant the holders of preferred stock the right to elect some number of Arlo’s directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences that Arlo could assign to holders of preferred stock could affect the residual value of the common stock. See “Description of Capital Stock.”

 

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We are an emerging growth company and as a result have certain reduced disclosure requirements in this prospectus.

We are an “emerging growth company” as defined in the JOBS Act and, as such, have elected to comply with certain reduced disclosure requirements for this prospectus and may elect to comply with certain reduced public company reporting requirements for future filings. As an emerging growth company, we are not required to disclose certain executive compensation information in this prospectus pursuant to the JOBS Act. We have also elected to present only two years of audited financial statements and the related section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this prospectus. In addition, the JOBS Act provides that an emerging growth company can delay adopting new or revised accounting standards until such time as those standards apply to private companies.

We will be a “controlled company” within the meaning of the applicable rules of the NYSE and, as a result, we may elect to rely on exemptions from certain corporate governance requirements that provide protection to stockholders of other companies. We do not currently expect or intend to rely on any of these exemptions, but we cannot assure that we will not rely on these exemptions in the future.

After the completion of this offering, NETGEAR will own more than 50% of the total voting power of our outstanding common stock, and we will be a “controlled company” under the applicable rules of the NYSE. As a controlled company, we may elect to rely on exemptions from certain of the applicable corporate governance requirements of the NYSE, including the requirements that:

 

    a majority of our board of directors consists of independent directors;

 

    we have a compensation committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities; and

 

    we have a nominating and corporate governance committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities.

As a result, while NETGEAR continues to control a majority of our outstanding common stock, we may elect not to comply with the corporate governance standards requiring (i) a majority of independent directors on the board; (ii) a fully independent compensation committee; and (iii) a fully independent nominating and corporate governance committee. We do not currently expect or intend to rely on any of these exemptions, but we cannot assure that we will not rely on these exemptions in the future. If we make such an election, you will not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of the NYSE. In the event that we cease to be a controlled company within the meaning of the applicable rules of the NYSE, we will be required to comply with these requirements after specified transition periods.

Certain provisions in our amended and restated certificate of incorporation and amended and restated bylaws and of Delaware law may prevent or delay an acquisition of Arlo, which could decrease the trading price of our common stock.

Our amended and restated certificate of incorporation and amended and restated bylaws will contain, and Delaware law contains, provisions that are intended to deter coercive takeover practices and inadequate takeover bids by making such practices or bids unacceptably expensive to the bidder and to encourage prospective acquirers to negotiate with our board of directors rather than to attempt a hostile takeover. These provisions include, among others:

 

    the inability of our stockholders to call a special meeting;

 

    the inability of our stockholders to act without a meeting of stockholders, from and after such time as NETGEAR beneficially owns shares of our common stock representing less than a majority of the voting rights of our common stock;

 

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    rules regarding how stockholders may present proposals or nominate directors for election at stockholder meetings;

 

    the right of our board of directors to issue preferred stock without stockholder approval;

 

    the division of our board of directors into three classes of directors, with each class serving a staggered three-year term, and this classified board provision could have the effect of making the replacement of incumbent directors more time consuming and difficult;

 

    a provision that, from and after such time as NETGEAR beneficially owns shares of our common stock representing less than a majority of the voting rights of our common stock, stockholders may only remove directors with cause while the board of directors is classified; and

 

    the ability of our directors, and not stockholders, to fill vacancies on our board of directors.

In addition, because we will not elect to be exempt from Section 203 of the Delaware General Corporation Law (the “DGCL”), this provision could also delay or prevent a change of control that you may favor. Section 203 provides that, subject to limited exceptions, persons that acquire, or are affiliated with a person that acquires, more than 15% of the outstanding voting stock of a Delaware corporation (an “interested stockholder”) shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which the person became an interested stockholder, unless (i) prior to such time, the board of directors of such corporation approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder; (ii) upon consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of such corporation at the time the transaction commenced (excluding for purposes of determining the voting stock outstanding (but not the outstanding voting stock owned by the interested stockholder) the voting stock owned by directors who are also officers or held in employee benefit plans in which the employees do not have a confidential right to tender or vote stock held by the plan); or (iii) on or subsequent to such time the business combination is approved by the board of directors of such corporation and authorized at a meeting of stockholders by the affirmative vote of at least two-thirds of the outstanding voting stock of such corporation not owned by the interested stockholder.

We believe these provisions will protect our stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirers to negotiate with our board of directors and by providing our board of directors with more time to assess any acquisition proposal. These provisions are not intended to make Arlo immune from takeovers. However, these provisions will apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that our board of directors determines is not in the best interests of Arlo and its stockholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors.

Our amended and restated certificate of incorporation will contain exclusive forum provisions that may discourage lawsuits against us and our directors and officers.

Our amended and restated certificate of incorporation will provide that unless the board of directors otherwise determines, the state courts in the State of Delaware or, if no state court located within the State of Delaware has jurisdiction, the federal court for the District of Delaware, will be the sole and exclusive forum for any derivative action or proceeding brought on behalf of Arlo, any action asserting a claim of breach of a fiduciary duty owed by any director or officer of Arlo to Arlo or Arlo’s stockholders, any action asserting a claim against Arlo or any director or officer of Arlo arising pursuant to any provision of the DGCL or Arlo’s amended and restated certificate of incorporation or bylaws, or any action asserting a claim against Arlo or any director or officer of Arlo governed by the internal affairs doctrine under Delaware law. Our amended and restated certificate of incorporation will further provide that the federal district courts of the United States will be the

 

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exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act. These exclusive forum provisions may limit the ability of Arlo’s stockholders to bring a claim in a judicial forum that such stockholders find favorable for disputes with Arlo or Arlo’s directors or officers, which may discourage such lawsuits against Arlo and Arlo’s directors and officers. Alternatively, if a court were to find one or more of these exclusive forum provisions inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings described above, Arlo may incur additional costs associated with resolving such matters in other jurisdictions or forums, which could materially and adversely affect Arlo’s business, financial condition or results of operations.

Our board of directors will have the ability to issue blank check preferred stock, which may discourage or impede acquisition attempts or other transactions.

Our board of directors will have the power, subject to applicable law, to issue series of preferred stock that could, depending on the terms of the series, impede the completion of a merger, tender offer or other takeover attempt. For instance, subject to applicable law, a series of preferred stock may impede a business combination by including class voting rights, which would enable the holder or holders of such series to block a proposed transaction. Our board of directors will make any determination to issue shares of preferred stock on its judgment as to our and our stockholders’ best interests. Our board of directors, in so acting, could issue shares of preferred stock having terms which could discourage an acquisition attempt or other transaction that some, or a majority, of the stockholders may believe to be in their best interests or in which stockholders would have received a premium for their stock over the then prevailing market price of the stock.

 

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USE OF PROCEEDS

We estimate that the net proceeds we will receive from the sale of our common stock in this offering, after deducting the underwriting discount and estimated offering expenses payable by us, will be approximately $173.1 million, assuming that the shares of our common stock to be sold in this offering are sold at $19.00 per share, the midpoint of the price range set forth on the cover page of this prospectus. If the underwriters exercise their option to purchase additional shares in full, we estimate our net proceeds will be approximately $200.1 million. We currently intend to use the net proceeds of this offering for general corporate purposes.

A $1.00 increase (decrease) in the assumed initial public offering price of $19.00 per share would increase (decrease) the net proceeds to us from this offering by $9.5 million, assuming the expected number of shares to be sold by us in this offering remains the same and after deducting the underwriting discount and estimated offering expenses payable by us.

We may also increase or decrease the number of shares we are offering. Each increase (decrease) of 1,000,000 shares in the number of shares offered by us would increase (decrease) the net proceeds to us by $17.7 million, assuming that the assumed initial public offering price of $19.00 per share (the midpoint of the price range set forth on the cover page of this prospectus) remains the same, and after deducting the underwriting discount and estimated offering expenses payable by us.

 

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DIVIDEND POLICY

We have never declared or paid cash dividends to holders of our capital stock. We currently intend to retain future earnings to finance the operation and expansion of our business. We do not anticipate paying any dividends on our common stock in the foreseeable future. As a result, you will need to sell your shares of common stock to receive any income or realize a return on your investment. You may not be able to sell your shares at or above the price you paid for them.

Any future determination to pay dividends will be at the discretion of our board of directors. If we do commence the payment of dividends in the future, there can be no assurance that we will continue to pay any dividend. Our board of directors is free to change our dividend policy at any time, including to increase, decrease or eliminate our dividend. The board will base its decisions on, among other things, general business conditions, our results of operations, financial condition, cash requirements, prospects, contractual, legal and regulatory restrictions regarding dividend payments by our subsidiaries and any other factors the board may consider relevant. No assurance is given that we will pay any dividends to holders of our capital stock or as to the amount of any such dividends if our board of directors determines to do so.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of April 1, 2018:

 

    on an actual basis;

 

    on a pro forma basis to reflect the transactions described in the section titled “Unaudited Pro Forma Condensed Combined Financial Statements” other than this offering; and

 

    on a pro forma as adjusted basis to give effect to the transactions described in the section titled “Unaudited Pro Forma Condensed Combined Financial Statements,” including this offering.

The information below is not necessarily indicative of what our cash and cash equivalents and capitalization would have been had the separation or this offering been completed as of April 1, 2018. In addition, it is not indicative of our future cash and cash equivalents and capitalization. This table is derived from, and should be read in conjunction with our historical combined financial statements and our unaudited pro forma condensed combined financial statements and the notes thereto included elsewhere in this prospectus, and should be read in conjunction with the sections titled “Selected Combined Financial Data,” “Unaudited Pro Forma Condensed Combined Financial Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our combined financial statements and notes thereto included elsewhere in this prospectus.

 

    

As of April 1, 2018

 
    

Actual

    

Pro Forma

    

Pro Forma

as  Adjusted(1)

 
    

(In thousands, except share and

per share data)

 

Cash and cash equivalents

   $ 178      $ 70,178      $ 243,247  
  

 

 

    

 

 

    

 

 

 

Equity:

        

Preferred stock, $0.001 par value (authorized – no shares actual, 50,000,000 shares pro forma and 50,000,000 shares pro forma as adjusted; issued and outstanding – no shares actual, no shares pro forma and no shares pro forma as adjusted(2))

   $ —        $ —        $ —    

Common stock, $0.001 par value (authorized – no shares actual, 500,000,000 shares pro forma and 500,000,000 shares pro forma as adjusted; issued and outstanding – no shares actual, 62,500,000 shares pro forma and 72,715,000 shares pro forma as adjusted(2))

     —          —          73  

Additional paid-in capital

     —          111,055        284,051  

Net parent investment

     92,937        —          —    
  

 

 

    

 

 

    

 

 

 

Total equity

   $ 92,937      $ 111,055      $ 284,124  
  

 

 

    

 

 

    

 

 

 

Total capitalization

   $ 92,937      $ 111,055      $ 284,124  
  

 

 

    

 

 

    

 

 

 

 

(1)  Each $1.00 increase (decrease) in the assumed initial public offering price of $19.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease) total equity by $9.5 million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting the underwriting discount and estimated offering expenses payable by us.

 

   We may also increase or decrease the number of shares we are offering. Each increase (decrease) of 1,000,000 shares in the number of shares offered by us would increase (decrease) total equity by $17.7 million, assuming that the assumed initial public offering price remains the same, and after deducting the underwriting discount and estimated offering expenses payable by us.

 

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   The pro forma as adjusted information discussed above is illustrative only and will adjust based on the actual initial public offering price and other terms of this offering determined at pricing.

 

(2)  The number of shares of common stock issued and outstanding on a pro forma as adjusted basis assumes the underwriters do not exercise their option to purchase additional shares.

 

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DILUTION

If you invest in our common stock, your ownership interest will be diluted to the extent that the initial public offering price per share of our common stock exceeds the tangible book value per share of our common stock immediately following this offering.

Pro forma net tangible book value represents our total tangible assets (total assets less intangible assets) less total liabilities, divided by the pro forma number of outstanding shares of common stock. As of April 1, 2018, our pro forma net tangible book value was $91.5 million, or $1.46 per share. After giving effect to the sale and issuance of 10,215,000 shares of our common stock in this offering at an assumed initial public offering price of $19.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, and after deducting the underwriting discount and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of April 1, 2018 would have been $264.5 million, or $3.64 per share. This represents an immediate increase in pro forma as adjusted net tangible book value of $2.18 per share to our existing stockholder, NETGEAR, and an immediate dilution of $15.36 per share to new investors participating in this offering.

The following table illustrates this dilution on a per share basis to new investors:

 

Assumed initial price to public per share

      $ 19.00  

Pro forma net tangible book value per share as of April 1, 2018(1)

   $ 1.46     

Increase per share attributable to new investors(2)

   $ 2.18     
  

 

 

    

Pro forma as adjusted net tangible book value per share after this offering(3)

      $ 3.64  
     

 

 

 

Dilution per share to new investors

      $ 15.36  
     

 

 

 

 

(1)  Determined by dividing the net tangible book value of the contributed tangible assets (total assets less intangible assets) less total liabilities by the total number of common shares (62,500,000 common shares) to be issued to NETGEAR in connection with the separation.
(2)  Represents the difference between pro forma as adjusted net tangible book value per share after this offering and pro forma net tangible book value per share as of April 1, 2018.
(3)  Determined by dividing (i) pro forma as adjusted net tangible book value, which is our pro forma net tangible book value plus the cash proceeds of this offering at an assumed initial public offering price of $19.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, and after deducting the underwriting discount and estimated offering expenses payable by us, by (ii) the total number of our common shares to be outstanding following this offering.

Each $1.00 increase (decrease) in the assumed initial public offering price of $19.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease) our pro forma as adjusted net tangible book value by $9.5 million, or $0.13 per share, and increase (decrease) the dilution per share to investors participating in this offering by $0.87 per share, assuming that the number of shares offered by us remains the same and after deducting the underwriting discount and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. An increase of 1,000,000 in the number of shares offered by us would increase our pro forma as adjusted net tangible book value by $17.7 million, or $0.19 per share, and decrease the dilution per share to investors participating in this offering by $0.19 per share to $15.17, assuming that the assumed initial public offering price remains the same, and after deducting the underwriting discount and estimated offering expenses payable by us. Similarly, a decrease of 1,000,000 shares in the number of shares offered by us would decrease our pro forma as adjusted net tangible book value by $17.7 million, or $0.20 per share, and increase the dilution per share to investors participating in this offering by $0.20 per share to $15.56, assuming that the assumed initial public offering price remains the same, and after deducting the underwriting discount and estimated offering expenses payable by us.

 

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The pro forma as adjusted information discussed above is illustrative only and will adjust based on the actual initial public offering price and other terms of this offering determined at pricing.

If the underwriters exercise their option to purchase additional shares in full, the pro forma as adjusted net tangible book value per share after this offering would be $3.93 per share, the incremental increase in the pro forma net tangible book value per share to our existing stockholder, NETGEAR, would be $2.47 per share and the pro forma dilution to new investors participating in this offering would be $15.07 per share.

The following table summarizes, on the pro forma as adjusted basis described above as of April 1, 2018, the differences between the number of shares of common stock purchased from us, the total consideration and the price per share paid by our existing stockholder, NETGEAR, and by investors participating in this offering at an assumed initial public offering price of $19.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, before deducting the underwriting discount and estimated offering expenses payable by us.

 

     Shares Purchased     Total Consideration
(In thousands)
    Weighted-
Average
Price Per

Share
 
     Number     Percent     Amount      Percent    

NETGEAR

     62,500,000 (1)      86.0   $ —          —     $ —    

Investors participating in this offering

     10,215,000       14.0   $ 194,085        100.0   $ 19.00  
  

 

 

   

 

 

   

 

 

    

 

 

   

Total

     72,715,000       100.0   $ 194,085        100.0   $ 2.67  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

(1)  Represents the total number of common shares to be issued to NETGEAR in connection with the separation.

Each $1.00 increase (decrease) in the assumed initial public offering price of $19.00 per share would increase (decrease) total consideration paid by new investors by $9.5 million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discount and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. An increase (decrease) of 1,000,000 in the number of shares offered by us would increase (decrease) total consideration paid by new investors by $17.7 million, assuming that the assumed initial public offering price remains the same, and after deducting the underwriting discount and estimated offering expenses payable by us.

 

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SELECTED COMBINED FINANCIAL DATA

The following financial data should be read in conjunction with our audited combined financial statements and the related notes, and our unaudited pro forma condensed combined financial statements and the related notes, included elsewhere in this prospectus.

The following table summarizes our historical combined financial data. The selected historical combined balance sheet data as of December 31, 2017 and 2016 and statements of operations data for the years ended December 31, 2017 and 2016 are derived from our audited combined financial statements included elsewhere in this prospectus. The selected historical combined balance sheet data as of April 1, 2018 and statements of operations data for the three months ended April 1, 2018 and April 2, 2017 are derived from our unaudited interim combined financial statements included elsewhere in this prospectus. We have prepared the unaudited interim combined financial statements on the same basis as the audited combined financial statements and have included all adjustments, consisting only of normal recurring adjustments that, in our opinion, are necessary to state fairly the financial information set forth in those statements. The selected combined financial data in this section are not intended to replace our combined financial statements and the related notes and are qualified in their entirety by the combined financial statements and related notes included elsewhere in this prospectus.

The selected combined financial data includes certain expenses of NETGEAR that were allocated to us for certain corporate functions including executive management, information technology, legal, finance and accounting, human resources, tax, treasury, research and development, sales and marketing activities, shared facilities and other shared services. Management believes the assumptions underlying the combined financial statements, including the assumptions regarding allocated expenses, reasonably reflect the utilization of services provided to, or the benefit received by, us during the periods presented. However, these shared expenses may not represent the amounts that would have been incurred had we operated autonomously or independently from NETGEAR. Actual costs that would have been incurred if we had been a stand-alone company would depend on multiple factors, including organizational structure and strategic decisions in various areas, such as information technology and infrastructure. In addition, our historical combined financial data does not reflect changes that we expect to experience in the future as a result of our separation from NETGEAR, including changes in our cost structure, personnel needs, tax structure, capital structure, financing and business operations.

Our annual combined financial statements also do not reflect the assignment of certain assets and liabilities between NETGEAR and us as reflected under the section titled “Unaudited Pro Forma Condensed Combined Financial Statements” included elsewhere in this prospectus. Consequently, the financial information included in this section may not necessarily reflect what our financial position, results of operations and cash flows would have been had we been a stand-alone company during the periods presented. Accordingly, these historical results should not be relied upon as an indicator of our future performance.

The following selected historical combined financial data should be read in conjunction with the sections titled “Use of Proceeds,” “Capitalization,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Unaudited Pro Forma Condensed Combined Financial Statements” and the related notes and the annual combined financial statements and the related notes included elsewhere in this prospectus.

 

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Combined Statements of Operations Data:

 

     Three Months Ended     Year Ended December 31,  
     April 1, 2018     April 2, 2017     2017      2016  
     (In thousands)  

Revenue

   $ 100,638     $ 61,803     $ 370,658      $ 184,604  

Cost of revenue (1)

     71,585       45,450       279,424        146,570  
  

 

 

   

 

 

   

 

 

    

 

 

 

Gross profit

     29,053       16,353       91,234        38,034  
  

 

 

   

 

 

   

 

 

    

 

 

 

Operating expenses:

         

Research and development (1)

     12,025       7,984       34,683        24,438  

Sales and marketing (1)

     11,212       5,721       34,340        18,455  

General and administrative (1)

     4,878       2,745       15,096        8,289  

Separation expense

     6,557       —         1,384        —    
  

 

 

   

 

 

   

 

 

    

 

 

 

Total operating expenses

     34,672       16,450       85,503        51,182  
  

 

 

   

 

 

   

 

 

    

 

 

 

Income (loss) from operations

  

 

 

 

(5,619

 

 

 

 

 

(97

 

    5,731        (13,148

Other income (expense), net

  

 

 

 

 

 

575

 

 

 

 

 

 

 

 

 

340

 

 

 

    1,946        (512
  

 

 

   

 

 

   

 

 

    

 

 

 

Income (loss) before income taxes

  

 

 

 

 

 

(5,044

 

 

 

 

 

 

 

 

243

 

 

 

    7,677        (13,660

Provision for income taxes

     319       219       1,128        83  
  

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ (5,363   $ 24     $ 6,549      $ (13,743
  

 

 

   

 

 

   

 

 

    

 

 

 

 

(1)  Stock-based compensation expense was allocated as follows:

 

     Three Months Ended  
     April 1, 2018      April 2, 2017  
     Direct      Allocated      Total      Direct      Allocated      Total  
     (In thousands)  

Cost of revenue

   $ 46      $ 290      $ 336      $ 23      $ 109      $ 132  

Research and development

     564        169        733        624        83        707  

Sales and marketing

     242        430        672        31        126        157  

General and administrative

     —        954        954        —        451        451  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 852      $ 1,843      $ 2,695      $ 678      $ 769      $ 1,447  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Year Ended December 31,  
     2017      2016  
     Direct      Allocated      Total      Direct      Allocated      Total  
     (In thousands)  

Cost of revenue

   $ 102      $ 599      $ 701      $ 61      $ 266      $ 327  

Research and development

     1,959        455        2,414        1,349        195        1,544  

Sales and marketing

     390        866        1,256        110        407        517  

General and administrative

     —          2,547        2,547        —          1,216        1,216  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,451      $ 4,467      $ 6,918      $ 1,520      $ 2,084      $ 3,604  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Combined Balance Sheet Data:

 

    As of      As of December 31,  
    April 1, 2018      2017      2016  
   

(In thousands)

 

Cash and cash equivalents

  $ 178      $ 108      $ 220  

Working capital

  $ 81,901      $ 112,878      $ 54,967  

Total assets

  $ 235,751      $ 269,820      $ 158,581  

Deferred revenue, current and non-current

  $ 40,420      $ 47,404      $ 23,393  

Total liabilities

  $ 142,814      $ 144,401      $ 85,407  

Total equity

  $ 92,937      $ 125,419      $ 73,174  

 

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UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS

The unaudited pro forma condensed combined financial statements consist of the unaudited pro forma condensed combined statements of operations for the three months ended April 1, 2018 and the year ended December 31, 2017, and the unaudited pro forma condensed combined balance sheet as of April 1, 2018. The unaudited pro forma condensed combined financial statements have been derived by application of pro forma adjustments to our historical combined financial statements included elsewhere in this prospectus.

The unaudited pro forma condensed combined balance sheet reflects the separation and this offering, as described below, as if they occurred on April 1, 2018, while the unaudited pro forma condensed combined statements of operations give effect to the separation and this offering as if they occurred on January 1, 2017. The pro forma adjustments, described in the related notes, are based on currently available information and certain estimates and assumptions that management believes are reasonable. These estimates and assumptions are preliminary and have been made solely for purposes of developing these unaudited pro forma condensed combined financial statements. Actual results could differ, perhaps materially, from these estimates and assumptions. Included in the pro forma adjustments are items that are directly related to the separation and this offering, factually supportable and, for purposes of the unaudited pro forma condensed combined statements of operations, have a continuing impact.

The unaudited pro forma condensed combined financial statements are provided for illustrative purposes only and are not necessarily indicative of the operating results or financial position that would have occurred had the separation from NETGEAR or this offering been completed on April 1, 2018 for the unaudited pro forma condensed combined balance sheet or on January 1, 2017 for the unaudited pro forma condensed combined statements of operations. The unaudited pro forma condensed combined financial statements should not be relied on as indicative of the historical operating results that we would have achieved or any future operating results or financial position that we will achieve after the completion of this offering.

The unaudited pro forma condensed combined financial statements reflect the impact of certain transactions, which primarily comprise the following:

 

    the separation, which outlines the assets and liabilities to be contributed by NETGEAR to Arlo at separation date as described in the section titled “Certain Relationships and Related Party Transactions—Relationship with NETGEAR”; and

 

    the receipt of approximately $173.1 million in net proceeds from the sale of shares of our common stock in this offering at an assumed initial offering price of $19.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, after deducting the underwriting discount and estimated offering expenses payable by us.

We have operated as an operating segment of NETGEAR since 2017. NETGEAR currently provides certain services to us, and costs associated with these functions have been allocated to us. The allocations include costs related to corporate services, such as executive management, information technology, legal, finance and accounting, human resources, tax, treasury, research and development, sales and marketing, shared facilities and other services. These costs were allocated on a basis of revenue, headcount or other measures we have determined as reasonable. The stock-based compensation includes expense attributable to our employees and an allocation of stock-based compensation attributable to employees of NETGEAR. These allocations are primarily reflected within operating expenses in our combined statements of operations. Management believes the basis on which the expenses have been allocated to be a reasonable reflection of the utilization of services provided to, or the benefit received by, us during the periods presented. However, these allocations may not necessarily be indicative of the actual expenses we would have incurred as an independent company during the periods prior to the offering or of the costs we will incur in the future. The amount of these allocations from NETGEAR was $13.8 million for the three months ended April 1, 2018, which included $4.3 million for research and

 

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development, $4.6 million for sales and marketing and $4.9 million for general and administrative expense. For the year ended December 31, 2017, allocations amounted to $40.0 million, which included $11.8 million for research and development, $13.1 million for sales and marketing and $15.1 million for general and administrative expense.

Following the completion of this offering, we expect NETGEAR to continue to provide certain of the services described above on a transitional basis for a fee. These services will be provided under the transition services agreement described in “Certain Relationships and Related Party Transactions—Relationship with NETGEAR—Arrangements Between NETGEAR and Our Company.” We generally expect to use the vast majority of these services for less than a year following the completion of this offering, depending on the type of the service and the location at which such service is provided. However, we may agree with NETGEAR to extend the service periods for a limited amount of time (which period will not extend past the first anniversary of the distribution) or may terminate such service periods by providing prior written notice. The unaudited pro forma condensed combined financial statements have not been adjusted for the effects of these transition services as we believe the allocation for such services, as previously described, is fairly reflected within the results presented. We estimate that the total cost for such services to be in the approximate range of $5.0 million to $10.0 million.

Following the completion of this offering, we will be subject to the reporting requirements of the Exchange Act. We will be required to establish procedures and practices as a stand-alone public company in order to comply with our obligations under the Exchange Act and related rules and regulations. As a result, we will incur additional costs, including internal audit, investor relations, stock administration and regulatory compliance costs. These additional costs may differ from the costs that were historically allocated to us from NETGEAR. To operate as a stand-alone company, we expect to incur costs to replace certain services previously provided by NETGEAR, which may be higher than those reflected in our historical combined financial statements. A component of these costs are IT-related costs, including capital expenditures, to implement certain new systems, including infrastructure and an enterprise resource planning system, while our legacy systems are being fully supported by NETGEAR, which we estimate to be $35.0 million to $55.0 million in the next 12 months. Any costs that have been incurred in the three months ended April 1, 2018 and the year ended December 31, 2017 related to the separation have been removed from the unaudited pro forma condensed combined statements of operations as they do not have a continuing impact. Any costs that have been incurred and qualify for capitalization as of April 1, 2018 are included in our unaudited pro forma condensed combined balance sheet and will be contributed by NETGEAR to Arlo as part of the separation. Costs that have not yet been incurred are not included in the unaudited pro forma condensed combined financial statements as the estimate of these costs is not factually supportable at this time. Actual costs that may have been incurred had we been a stand-alone company depend on a number of factors, including organizational structure and decisions made relating to various areas such as information technology and infrastructure.

The following unaudited pro forma condensed combined financial statements and the related notes should be read in conjunction with the sections titled “Use of Proceeds,” “Capitalization” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the annual audited combined financial statements, the unaudited interim combined financial statements and the related notes included elsewhere in this prospectus.

 

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Arlo

Unaudited Pro Forma Condensed Combined Balance Sheet

April 1, 2018

 

     Historical      Non-Offering
Pro Forma
Adjustments
(Note 1)
         Pro Forma
Adjustments
for this
Offering
(Note 1)
          Pro
Forma
as Adjusted
 
     (In thousands, except share and per share data)  
ASSETS                 

Current assets:

                

Cash and cash equivalents

   $ 178      $ 70,000     (a)    $ 173,069      (k)    $ 243,247  

Accounts receivable, net

     102,259        (102,259   (b)      —             —    

Inventories

     103,849        —            —             103,849  

Prepaid expenses and other current assets

     3,484        (1,110   (c)      —             2,374  
  

 

 

    

 

 

      

 

 

       

 

 

 

Total current assets

     209,770        (33,369        173,069           349,470  

Property and equipment, net

     3,668        775     (d)      —             4,443  

Intangibles, net

     3,967        —            —             3,967  

Goodwill

     15,638        —            —             15,638  

Other non-current assets

     2,708        (1,003   (e)      —             1,705  
  

 

 

    

 

 

      

 

 

       

 

 

 

Total assets

   $ 235,751      $ (33,597      $ 173,069         $ 375,223  
  

 

 

    

 

 

      

 

 

       

 

 

 
LIABILITIES AND EQUITY                 

Current liabilities:

                

Accounts payable

   $ 20,664      $ (20,664   (f)      —           $ —    

Deferred revenue

     25,634        —            —             25,634  

Accrued liabilities

     81,222        (31,596   (g)      —             49,626  

Income taxes payable

     349        (349   (h)      —             —    
  

 

 

    

 

 

      

 

 

       

 

 

 

Total current liabilities

     127,869        (52,609        —             75,260  

Non-current deferred revenue

     14,786        —            —             14,786  

Non-current income taxes payable

     159        (159   (h)      —             —    

Other non-current liabilities

     —          1,053     (i)      —             1,053  
  

 

 

    

 

 

      

 

 

       

 

 

 

Total liabilities

     142,814        (51,715        —             91,099  
  

 

 

    

 

 

      

 

 

       

 

 

 

Equity:

                

Preferred stock, $0.001 par value, 50,000,000 shares authorized; none issued or outstanding on a pro forma basis

     —          —            —             —    

Common Stock, $0.001 par value, 500,000,000 authorized shares; 72,715,000 issued and outstanding shares on a pro forma basis

     —          —            73      (k)      73  

Additional paid-in capital

     —          111,055     (j)      172,996      (k)      284,051  

Net parent investment

     92,937        (92,937   (j)      —             —    
  

 

 

    

 

 

      

 

 

       

 

 

 

Total equity

     92,937        18,118          173,069           284,124  
  

 

 

    

 

 

      

 

 

       

 

 

 

Total liabilities and equity

   $ 235,751      $ (33,597      $ 173,069         $ 375,223  
  

 

 

    

 

 

      

 

 

       

 

 

 

See notes to unaudited pro forma condensed combined financial statements

 

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Arlo

Unaudited Pro Forma Condensed Combined Statement of Operations

Three Months Ended April 1, 2018

 

     Historical     Non-Offering
Pro Forma
Adjustments
(Note 2)
         Pro Forma
Adjustments
for this
Offering
(Note 2)
         Pro
Forma
as Adjusted
 
     (In thousands, except per share data)  

Revenue

   $ 100,638     $ —          $ —          $ 100,638  

Cost of revenue

     71,585       —            —            71,585  
  

 

 

   

 

 

      

 

 

      

 

 

 

Gross profit

     29,053       —            —            29,053  
  

 

 

   

 

 

      

 

 

      

 

 

 

Operating expenses:

              

Research and development

     12,025       —            222     (n)      12,247  

Sales and marketing

     11,212       —            —            11,212  

General and administrative

     4,878       264     (l)      1,189     (n)      6,331  

Separation expense

     6,557       (6,557   (m)      —            —    
  

 

 

   

 

 

      

 

 

      

 

 

 

Total operating expenses

     34,672       (6,293        1,411          29,790  
  

 

 

   

 

 

      

 

 

      

 

 

 

Loss from operations

     (5,619     6,293          (1,411        (737

Other income (expense), net

     575       —            —            575  
  

 

 

   

 

 

      

 

 

      

 

 

 

Loss before income taxes

     (5,044     6,293          (1,411        (162

Provision for income taxes

     319       —       (o)      —       (o)      319  
  

 

 

   

 

 

      

 

 

      

 

 

 

Net loss

   $ (5,363   $ 6,293        $ (1,411      $ (481
  

 

 

   

 

 

      

 

 

      

 

 

 

Pro forma net loss per share:

              

Basic

     N/A               $ (0.01

Diluted

     N/A               $ (0.01

Pro forma weighted-average shares used to compute net loss per share:

              

Basic

     N/A       62,500     (p)      10,215     (p)      72,715  

Diluted

     N/A       62,500     (p)      10,215     (p)      72,715  

See notes to unaudited pro forma condensed combined financial statements.

 

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Arlo

Unaudited Pro Forma Condensed Combined Statement of Operations

Year Ended December 31, 2017

 

     Historical      Non-Offering
Pro Forma
Adjustments
(Note 2)
         Pro Forma
Adjustments
for this
Offering
(Note 2)
         Pro
Forma
as Adjusted
 
     (In thousands, except per share data)  

Revenue

   $ 370,658      $ —          $ —          $ 370,658  

Cost of revenue

     279,424        —            —            279,424  
  

 

 

    

 

 

      

 

 

      

 

 

 

Gross profit

     91,234        —            —            91,234  
  

 

 

    

 

 

      

 

 

      

 

 

 

Operating expenses:

               

Research and development

     34,683        —            1,289     (n)      35,972  

Sales and marketing

     34,340        —            —            34,340  

General and administrative

     15,096        1,323     (l)      6,903     (n)      23,322  

Separation expense

     1,384        (1,384   (m)      —            —    
  

 

 

    

 

 

      

 

 

      

 

 

 

Total operating expenses

     85,503        (61        8,192          93,634  
  

 

 

    

 

 

      

 

 

      

 

 

 

Income (loss) from operations

     5,731        61          (8,192        (2,400

Other income, net

     1,946        —            —            1,946  
  

 

 

    

 

 

      

 

 

      

 

 

 

Income (loss) before income taxes

     7,677        61          (8,192        (454

Provision for income taxes

     1,128        388     (o)      —       (o)      1,516  
  

 

 

    

 

 

      

 

 

      

 

 

 

Net income (loss)

   $ 6,549      $ (327      $ (8,192      $ (1,970
  

 

 

    

 

 

      

 

 

      

 

 

 

Pro forma net loss per share:

               

Basic

     N/A                $ (0.03

Diluted

     N/A                $ (0.03

Pro forma weighted-average shares used to compute net loss per share:

               

Basic

     N/A        62,500     (p)      10,215     (p)      72,715  

Diluted

     N/A        62,500     (p)      10,215     (p)      72,715  

See notes to unaudited pro forma condensed combined financial statements.

 

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Notes to Unaudited Pro Forma Condensed Combined Financial Statements

Note 1—Adjustments to the unaudited pro forma condensed combined balance sheet

In connection with the separation, NETGEAR will make a contribution to Arlo of certain assets and liabilities. Certain assets and liabilities were not reflected in the combined historical financial statements as they were not specifically identifiable to the Arlo business, while other specifically identifiable assets and liabilities previously presented will not be part of the contribution by NETGEAR. The following adjustments have been made to the unaudited pro forma condensed combined balance sheet to effect the separation and the offering:

 

(a) Reflects $70.0 million in cash that NETGEAR intends to contribute to us in the period leading up to the separation, a portion of which we may use prior to the separation for operating expenses, working capital and other requirements.

 

(b) Reflects the elimination of Accounts receivable as of April 1, 2018 that will not be part of the contribution by NETGEAR.

 

(c) Reflects the elimination of VAT receivable and rebates receivable that will not be part of the contribution by NETGEAR.

 

(d) Reflects the contribution of Property and equipment, net not historically designated as Arlo.

 

(e) Reflects the elimination of non-current deferred tax receivable as deferred tax is not being transferred as part of the contribution.

 

(f) Reflects the elimination of Accounts payable as of April 1, 2018 that will not be part of the contribution by NETGEAR.

 

(g) Reflects the elimination of accruals for committed sales and marketing programs, accrued freight and other accrued liabilities that will be settled by NETGEAR as part of the contribution. Sales with right of return reserves, accrued warranty and employee-related liabilities pertaining to Arlo employees are transferring as part of the contribution.

 

(h) Reflects the elimination of income taxes payable which will only accrue based on activities from the separation date forward.

 

(i) Reflects the transfer of liability for deferred rent relating to the Carlsbad corporate headquarters not historically designated as Arlo and being assumed by Arlo from the separation date forward.

 

(j) Reflects the elimination of Net parent investment and establishment of Additional paid-in capital as part of the contribution from NETGEAR to Arlo.

 

(k) Represents the receipt of approximately $173.1 million by us associated with the sale of shares of common stock in this offering at the initial public offering price of $19.00 per share (the midpoint of the price range set forth on the cover page of this prospectus) after deducting the underwriting discount and estimated offering expenses payable by us.

Note 2—Adjustments to the unaudited condensed combined statements of operations

The following adjustments have been made to the unaudited pro forma condensed combined statements of operations to effect the separation and this offering:

 

(l) Reflects the incremental rent expense relating to the lease agreement for the San Jose corporate headquarters executed in June 2018.

 

(m) Reflects the elimination of non-recurring transaction expenses, primarily for IT-related costs, and legal and professional services, we have incurred in connection with the separation.

 

(n)

Reflects new equity-based compensation arrangements with three named executive officers in connection with this offering (“IPO Options”), resulting in a $1.4 million increase in the stock-based compensation

 

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  expense for the three months ended April 1, 2018 and a $8.2 million increase in stock-based compensation expense for the year ended December 31, 2017. See the section titled “Executive Compensation”. The estimated fair values of these stock options for purposes of our pro forma adjustment will be recognized ratably over the performance periods or service periods ranging from one to four years.

 

(o) The change in income from the elimination of separation expense, addition of rent expense and stock-based compensation expense resulted in a larger U.S. book loss that is subject to a full valuation allowance. There was no impact on the profits of foreign jurisdictions where tax is incurred with the exception of changes to deferred tax for the year ended December 31, 2017. The pro forma tax provision change for the year ended December 31, 2017 resulted from the change in computed deferred tax expense due to differences in assets and liabilities that will be transferred to Arlo.

 

(p) Pro forma weighted-average shares outstanding is based on shares outstanding, which is the number of shares of our common stock expected to be outstanding following this offering. The calculation includes 10,215,000 shares assumed to be sold in this offering as of the date of this offering and 62,500,000 shares assumed issued to NETGEAR as part of the contribution.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

You should read the following discussion and analysis together with the section titled “Selected Combined Financial Data” and our combined financial statements and related notes included elsewhere in this prospectus. Among other things, those historical financial statements include more detailed information regarding the basis of presentation for the financial data included in the following discussion. This discussion contains forward-looking statements about our business, operations and industry that involve risks and uncertainties, such as statements regarding our plans, objectives, expectations and intentions. Our future results and financial condition may differ materially from those we currently anticipate as a result of the factors we describe under the sections titled “Cautionary Statement Regarding Forward-Looking Statements” and “Risk Factors.”

Overview

Arlo combines an intelligent cloud infrastructure and mobile app with a variety of smart connected devices that transform the way people experience the connected lifestyle. Our cloud-based platform creates a seamless, end-to-end connected lifestyle solution that provides customers visibility, insight and a powerful means to help protect and connect with the people and things that matter most to them. Arlo enables users to monitor their environments and engage in real-time with their families and businesses from any location with a Wi-Fi or a cellular network internet connection. To date, we have launched several categories of award-winning smart connected devices, including wire-free smart Wi-Fi and LTE-enabled cameras, advanced baby monitors and smart security lights. In addition, Arlo’s broad compatibility allows the platform to seamlessly integrate with third-party products and protocols, such as Amazon Alexa, Apple HomeKit, Apple TV, Google Assistant, IFTTT, Stringify and Samsung SmartThings. Since the launch of our first product in December 2014, we have shipped over 7.5 million smart connected devices, and, as of April 1, 2018, our smart platform had over 1.9 million registered users across more than 100 countries around the world. We plan to continue to introduce new smart connected devices to the Arlo platform in new categories, increase the number of registered users on our platform, keep them highly engaged through our mobile app and generate incremental recurring revenue by offering them paid subscription services.

We conduct business across three geographic regions - the Americas; Europe, Middle-East and Africa (“EMEA”); and Asia Pacific (“APAC”) - and we primarily generate revenue by selling devices through retail, wholesale distribution and wireless carrier channels and paid subscription services through in-app purchases. International revenue was 28.0% and 30.9% of our revenue for the three months ended April 1, 2018 and April 2, 2017, respectively, and 24.6% and 23.0% of our revenue for the years ended December 31, 2017 and 2016, respectively. We plan to replicate our success in the U.S. market elsewhere as we strategically expand into the global market.

Our goal is to continue to develop innovative, world-class connected lifestyle solutions to expand and further monetize our current and future user and subscriber bases. We believe that the growth of our business is dependent on many factors, including our ability to innovate and grow our installed base, to increase subscription-based recurring revenue, to invest in brand awareness and channel partnerships and to continue our global expansion. We expect to increase our investment in research and development as we continue to introduce new and innovative products and services to enhance the Arlo platform, and we also expect to incur separation expense as a result of the infrastructure required to be a stand-alone public company.

We have experienced significant growth since the shipment of our first product in December 2014. For the three months ended April 1, 2018 and April 2, 2017, we generated revenue of $100.6 million and $61.8 million, respectively, representing year-over-year growth of 62.8%. Loss from operations was $5.6 million for the three months ended April 1, 2018 compared with a loss from operations of $0.1 million for the three months ended April 2, 2017. Loss from operations for the three months ended April 1, 2018 included separation expense

 

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of $6.6 million. For the years ended December 31, 2017 and 2016, we generated revenue of $370.7 million and $184.6 million, respectively, representing year-over-year growth of 100.8%. Income from operations was $5.7 million for the year ended December 31, 2017 compared with a loss from operations of $13.1 million for the year ended December 31, 2016. Our registered user base has grown from 0.7 million registered users as of December 31, 2016 to over 1.9 million registered users as of April 1, 2018.

Key Business Metrics

In addition to the measures presented in our combined financial statements, we use the following key metrics to evaluate our business, measure our performance, develop financial forecasts and make strategic decisions. Our key business metrics may be calculated in a manner different than similar key business metrics used by other companies.

 

     Three Months Ended      Year Ended December 31,  
     April 1, 2018      % Change     April 2, 2017      2017      % Change     2016  
    

(In thousands, except percentage data)

 

Registered users

     1,929        123.3     864        1,670        143.1     687  

Devices shipped

     905        52.6     593        3,770        88.5     2,000  

Service revenue

   $ 8,207        43.0   $ 5,740      $ 29,077        138.7   $ 12,182  

Registered Users. We believe that our ability to increase our user base is an indicator of our market penetration and growth of our business as we continue to expand and innovate our Arlo platform. We define our registered users at the end of a particular period as the number of unique registered accounts on the Arlo app as of the end of such particular period. The number of registered users does not necessarily reflect the number of end-users on the Arlo platform, as one registered account may be used by multiple people.

Devices Shipped. Devices shipped represents the number of Arlo cameras and lights that are shipped to our customers during a period. Devices shipped does not include shipments of Arlo accessories and Arlo base stations, nor does it take into account returns of Arlo cameras and lights. The growth rate of our revenue is not necessarily correlated with our growth rate of devices shipped, as our revenue is affected by a number of other variables, including but not limited to returns from customers, sales of accessories and premium services, the types of Arlo products sold during the relevant period and the introduction of new product offerings that have different U.S. manufacturer’s suggested retail prices (“MSRPs”).

Service Revenue. Service revenue represents revenue recognized relating to prepaid services and paid service subscriptions. Our prepaid services pertain to devices which are sold with our Arlo prepaid services offering, providing users with the ability to store and access data for up to five cameras for a rolling seven-day period. Our paid subscription services relate to sales of subscription plans to our registered users.

Factors Affecting Our Business and Results of Operations

Product and Service Introductions and Subscription-Based Service Revenue

To date, product introductions have had a significant positive impact on our operating results due primarily to increases in revenue associated with sales of the new products in the quarters following their introduction. Since the end of 2014, we have released numerous new connected lifestyle devices, including the original Arlo Security Camera, Arlo Pro, Arlo Pro 2, Arlo Q and Arlo Q plus, Arlo Go, Arlo Baby and the Arlo Security Light. We have also released several services for our home and business users, including our Arlo Smart services, a collection of paid features that provide users with actionable intelligence and rich app notifications through the Arlo app, such as person-detection capabilities, e911 functionality and motion zone customization. The majority of our revenue to date has been derived from the sale of our Arlo cameras with new product introductions contributing significantly to revenue growth in the quarters following their introduction. In the

 

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future, we plan to continue to introduce new categories of devices and services that will connect to and complement the Arlo platform, and we expect that our operating results will be impacted by these releases. We also believe we can grow our subscription-based recurring revenue stream by improving current Arlo Smart service features and introducing new premium service features to our growing user base. However, we cannot be assured that our new product or service introductions will have a favorable impact on our operating results or that customers will choose our new products and services over those of our competitors.

Adoption of Connected Lifestyle Technology

Our total addressable market consists of individuals and business owners who use connected devices to enhance their lives. According to Gartner, consumer IoT endpoints hardware and services spending will reach $1.8 trillion by 2021.(1) Gartner estimates our addressable market for the global connected home alone, including elements of consumer IoT services spending and IoT endpoints hardware spending, will grow from $45 billion in 2017 to $146 billion in 2021, representing a compound annual growth rate (“CAGR”) of 34%.(2) Outside of the home, we have seen adoption of our cellular-enabled products in a variety of use cases, such as construction site monitoring, neighborhood watch, wildlife and outdoor trail surveillance and event monitoring. We believe the small business and government segments represent additional growth areas for us. We expect that continued growth in the adoption of cloud technologies, AI-empowered data analytics and IoT devices within and outside the home and business will expand our addressable market. However, our future growth depends in part on the continued adoption of these devices and technologies in the future.

Investments in Sales, Marketing and the Arlo Brand

We plan to invest significant resources in growing brand awareness through direct and indirect marketing, to develop and introduce new products and services and to enter new markets and channels as we seek to continue to grow the number of registered users. We believe our user base represents a significant opportunity to increase revenue, particularly paid subscription service revenue. We expect to continue to accelerate investments in sales, marketing and brand awareness to grow the number of registered users while also rolling out new and improved paid subscription service offerings. Such investments may occur in advance of any sales benefits from these activities, and it may be difficult for us to determine if we are efficiently allocating our resources or obtaining an appropriate return on our investment in these areas.

Seasonality

Historically, we have generated higher revenue in the third and fourth quarters of each year compared to the first and second quarters due to seasonal demand from consumer markets primarily relating to the beginning of the school year and the holiday season. For example, for the years ended December 31, 2017 and 2016, our third and fourth quarters collectively represented 62.0% and 65.5%, respectively, of our revenue for such years. Therefore, timely and effective product and service introductions are critical to our results of operations.

Comparability of Historical Results

Our historical combined financial statements, which are discussed below, are prepared on a stand-alone basis in accordance with U.S. generally accepted accounting principles (“GAAP”) and are derived from NETGEAR’s consolidated financial statements and accounting records using the historical results of operations and assets and liabilities attributed to our operations, and include allocations of expenses from NETGEAR. Our combined results are not necessarily indicative of our future performance and do not reflect what our financial performance would have been had we been a stand-alone public company during the periods presented.

 

(1)  Gartner, Forecast: Internet of Things — Endpoints and Associated Services, Worldwide, 2017, 21 December 2017, Table 4.1.
(2)  Gartner, Forecast: Internet of Things — Endpoints and Associated Services, Worldwide, 2017, 21 December 2017, Table 4.1 (Home Automation/Other, Home Energy Management, Home Security and Safety) & 12.1 (Home Security and Safety, Home Automation, Energy Management, Other).

 

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NETGEAR currently provides certain services to us, and costs associated with these functions have been allocated to us. The allocations include costs related to corporate services, such as executive management, information technology, legal, finance and accounting, human resources, tax, treasury, research and development, sales and marketing, shared facilities and other services. These costs were allocated on a basis of revenue, headcount or other measures we have determined as reasonable. The stock-based compensation includes expense attributable to our employees and an allocation of stock-based compensation attributable to employees of NETGEAR. These allocations are primarily reflected within operating expenses in our combined statements of operations. Management believes the basis on which the expenses have been allocated to be a reasonable reflection of the utilization of services provided to, or the benefit received by, us during the periods presented. However, these allocations may not necessarily be indicative of the actual expenses we would have incurred as an independent company during the periods prior to the offering or of the costs we will incur in the future. The amount of these allocations from NETGEAR was $13.8 million for the three months ended April 1, 2018, which included $4.3 million for research and development, $4.6 million for sales and marketing and $4.9 million for general and administrative expense. Allocations amounted to $6.9 million for the three months ended April 2, 2017, which included $2.0 million for research and development, $2.2 million for sales and marketing and $2.7 million for general and administrative expense. For the year ended December 31, 2017, allocations amounted to $40.0 million, which included $11.8 million for research and development, $13.1 million for sales and marketing and $15.1 million for general and administrative expense. For the year ended December 31, 2016, allocations amounted to $20.6 million, which included $5.9 million for research and development, $6.4 million for sales and marketing and $8.3 million for general and administrative expense.

Our Relationship with NETGEAR

Following the completion of this offering, we expect NETGEAR to continue to provide certain of the services described above on a transitional basis for a fee. These services will be provided under the transition services agreement described in “Certain Relationships and Related Party Transactions—Relationship with NETGEAR—Arrangements Between NETGEAR and Our Company.” We generally expect to use the vast majority of these services for less than a year following the completion of this offering, depending on the type of the service and the location at which such service is provided. However, we may agree with NETGEAR to extend the service periods for a limited amount of time (which period will not extend past the first anniversary of the distribution) or may terminate such service periods by providing prior written notice.

Following the completion of this offering, we will be subject to the reporting requirements of the Exchange Act. We will be required to establish procedures and practices as a stand-alone public company in order to comply with our obligations under the Exchange Act and related rules and regulations. As a result, we will incur additional costs, including internal audit, investor relations, stock administration and regulatory compliance costs. These additional costs may differ from the costs that were historically allocated to us from NETGEAR. To operate as a stand-alone company, we expect to incur costs to replace certain services previously provided by NETGEAR, which may be higher than those reflected in our historical combined financial statements. A component of these costs are IT-related costs, including capital expenditures, to implement certain new systems, including infrastructure and an enterprise resource planning system, while our legacy systems are being fully supported by NETGEAR, which we estimate to be $35.0 million to $55.0 million in the next 12 months.

Components of Our Operating Results

Revenue

Our gross revenue consists primarily of sales of devices, and to a much lesser extent, prepaid and paid subscription service revenue. We generally recognize revenue from product sales at the time the product is shipped. Our prepaid services primarily pertain to devices which are sold with our Arlo prepaid services offering,

 

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providing users with the ability to store and access data for up to five cameras for a rolling seven-day period. Upon device shipment, we attribute a portion of the sales price to the prepaid service, deferring this revenue at the outset and subsequently recognizing ratably over the estimated useful life of the device. Our paid subscription services relate to sales of subscription plans to our registered users.

Our revenue consists of gross revenue, less end-user customer rebates and other channel sales incentives deemed to be a reduction of revenue per the authoritative guidance for revenue recognition, allowances for estimated sales returns, price protection and net changes in deferred revenue. A significant portion of our marketing expenditures is with customers and is deemed to be a reduction of revenue under authoritative guidance for revenue recognition. See the section titled “—Critical Accounting Policies and Estimates—Revenue Recognition” below for details.

Our revenue can vary based on a number of factors, including changes in average selling prices, end-user customer rebates and other channel sales incentives, uncertainties surrounding demand for our products and allowances for estimated sales returns, including future pricing and/or potential discounts as a result of competition or in response to fluctuations of the U.S. dollar in our international markets, and related production level variances; changes in technology; and adoption of our current and future paid subscription service offerings.

We continue to experience robust user demand across all regions for our Arlo products. We believe this demand will lead to an increase in absolute dollars in prepaid and paid subscription service revenues as our number of registered users continues to grow. Furthermore, we expect that as we introduce more features to our subscription services, the rate of adoption of our paid subscription services will increase which we expect to increase revenue. While we expect prepaid and paid subscription services to grow, we anticipate revenue from device sales will continue to generate the majority of our revenue for the foreseeable future.

Cost of Revenue

Cost of revenue consists of both product costs and costs of service. Product costs primarily consist of: the cost of finished products from our third-party manufacturers; overhead costs, including purchasing, product planning, inventory control, warehousing and distribution logistics, third-party software licensing fees, inbound freight, warranty costs associated with returned goods, write-downs for excess and obsolete inventory, royalties to third parties; and amortization expense of certain acquired intangibles. Cost of service consists of cost attributable to the provision and maintenance of our cloud-based platform, including storage, security and computing.

Our cost of revenue as a percentage of revenue can vary based upon a number of factors, including those that may affect our revenue set forth above and factors that may affect our cost of revenue, including, without limitation: registered user acceptance of paid subscription service offerings, fluctuation in foreign exchange rates and changes in our cost of goods sold due to fluctuations in prices paid for components, net of vendor rebates, cloud platform costs, warranty and overhead costs, inbound freight and duty product conversion costs, charges for excess or obsolete inventory and amortization of acquired intangibles. We outsource our manufacturing, warehousing and distribution logistics. We also outsource certain components of the required infrastructure to support our cloud-based back-end information technology (“IT”) infrastructure. We believe this outsourcing strategy allows us to better manage our product and services costs and gross margin.

We expect that revenue derived from paid subscription service plans will increase as a percentage of our revenue in the future, which may have a positive impact on our gross margin. From time to time, however, we may experience fluctuations in our gross margin as a result of the factors discussed above.

Research and Development

Research and development expense consists primarily of personnel-related expense, safety, security, regulatory testing, other consulting fees and IT and facility overhead. We recognize research and development

 

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expense as it is incurred. We have invested in building our research and development organization to enhance our ability to introduce innovative products and services. We believe that innovation and technological leadership are critical to our future success, and we are committed to continuing a significant level of research and development to develop new technologies, products and services, including our hardware devices, cloud-based software, AI-based algorithms and machine learning capabilities. We expect research and development expense to grow in absolute dollars as we continue to develop new product and service offerings to support the connected lifestyle market. We expect research and development expense to fluctuate depending on the timing and number of development activities in any given period, and such expense could vary significantly as a percentage of revenue, depending on actual revenue achieved in any given period.

Sales and Marketing

Sales and marketing expense consists primarily of personnel expense for sales and marketing staff technical support expense, advertising, trade shows, corporate communications and other marketing expense, product marketing expense, IT and facilities overhead; outbound freight costs and amortization of certain intangibles. We expect our sales and marketing expense to increase in absolute dollars for the foreseeable future as we continue to invest in brand marketing to strengthen our competitive position, to accelerate growth and to raise brand awareness.

General and Administrative

General and administrative expense consists primarily of personnel-related expense for certain executives, finance and accounting, human resources, information technology, professional fees, IT and facility overhead, and other general corporate expense. We expect our general and administrative expense to increase in absolute dollars primarily as a result of the increased costs associated with being a stand-alone public company. However, we also expect our general and administrative expense to fluctuate as a percentage of our revenue in future periods based on fluctuations in our revenue and the timing of such expense.

Separation Expense

Separation expense consists primarily of costs associated with our separation from NETGEAR, including third-party advisory, consulting, legal and professional services, IT-related expenses directly related to our separation from NETGEAR, and other items that are incremental and one-time in nature. To operate as a stand-alone company, we expect to incur increased separation costs to replace certain services previously provided by NETGEAR, which may be higher than those reflected in our historical combined financial statements. See the sections titled “Certain Relationships and Related Party Transactions—Relationship with NETGEAR” and “Unaudited Pro Forma Condensed Combined Financial Statements.”

Other Income (Expense), Net

Other income (expense), net primarily represents gains and losses on transactions denominated in foreign currencies and other miscellaneous income and expense.

Income Taxes

Our business has historically been included in NETGEAR’s consolidated U.S. federal income tax return. We have adopted the separate return approach for the purpose of the Arlo financial statements. The income tax provisions and related deferred tax assets and liabilities that have been reflected in our historical combined financial statements have been estimated as if we were a separate taxpayer. The historic operations of the Arlo business reflect a separate return approach for each jurisdiction in which Arlo had presence and NETGEAR filed a tax return. We record a provision for income taxes for the anticipated tax consequences of the reported results

 

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of operations using the asset and liability method. Under this method, we recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities, as well as for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. To effect the separation of the Arlo business from NETGEAR’s other businesses, there will be changes to the organizational structure of the business, which will not impact our historical financial statements.

We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. As we expand internationally, we will face increased complexity in determining the appropriate tax jurisdictions for revenue and expense items which may differ from that of NETGEAR. Our policy is to adjust these reserves when facts and circumstances change, such as the closing of a tax audit or refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made and could have a material impact on our financial condition and operating results. The provision for income taxes includes the effects of any accruals that we believe are appropriate, as well as the related net interest and penalties.

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) was signed into law, making significant changes to the Internal Revenue Code of 1986, as amended (the “Code”). Changes include, but are not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years beginning after December 31, 2017, the transition of U.S international taxation from a worldwide tax system to a territorial system and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings. The recently enacted Tax Act significantly changed how the United States taxes corporations. At this time, significant judgment is required in implementing the law due to the lack of sufficient interpretive guidance from the U.S. or state regulatory bodies and standards settings bodies. Computations required are complex and data-intensive. The amounts reported as of December 31, 2017 are provisional based on the uncertainty discussed above. As we complete our analysis and prepare necessary data, and interpret any additional guidance, we will adjust our calculations and provisional amounts that we have recorded in our tax provision. Any such adjustments may materially impact our provision for income taxes in our financial statements.

Fiscal Periods

Our fiscal year begins on January 1 of the year stated and ends on December 31 of the same year. We report our results on a fiscal quarter basis rather than on a calendar quarter basis. Under the fiscal quarter basis, each of the first three fiscal quarters ends on the Sunday closest to the calendar quarter end, with the fourth quarter ending on December 31.

 

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Results of Operations

We operate as one operating and reportable segment. The following table sets forth, for the periods presented, the combined statements of operations data, which we derived from the accompanying combined financial statements:

 

     Three Months Ended     Year Ended December 31,  
     April 1,
2018
    April 2,
2017
    2017     2016  
    

(In thousands, except percentage data)

 

Revenue

   $ 100,638       100.0   $ 61,803       100.0   $ 370,658        100.0   $ 184,604       100.0

Cost of revenue

     71,585       71.1     45,450       73.5     279,424        75.4     146,570       79.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Gross profit

     29,053       28.9     16,353       26.5     91,234        24.6     38,034       20.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Operating expenses:

                 

Research and development

     12,025       11.9     7,984       12.9     34,683        9.4     24,438       13.2

Sales and marketing

     11,212       11.3     5,721       9.4     34,340        9.3     18,455       10.0

General and administrative

     4,878       4.8     2,745       4.4     15,096        4.1     8,289       4.5

Separation expense

     6,557       6.5     —         —       1,384        0.3     —         —  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total operating expenses

     34,672       34.5     16,450       26.7     85,503        23.1     51,182       27.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     (5,619     (5.6 )%      (97     (0.2 )%      5,731        1.5     (13,148     (7.1 )% 

Other income (expense), net

     575       0.6     340       0.6     1,946        0.6     (512     (0.3 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     (5,044     (5.0 )%      243       0.4     7,677        2.1     (13,660     (7.4 )% 

Provision for income taxes

     319       0.3     219       0.4     1,128        0.3     83       0.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (5,363     (5.3 )%    $ 24       0.0   $ 6,549        1.8   $ (13,743     (7.4 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Comparison of the Three Months Ended April 1, 2018 and April 2, 2017

Revenue by Geographic Region

We conduct business across three geographic regions: Americas, EMEA and APAC. We generally base revenue by geography on the ship-to location of the customer for device sales and device location for service sales.

 

     Three Months Ended  
     April 1,
2018
    % Change     April 2,
2017
 
     (In thousands, except percentage data)  

Americas

   $ 74,723       66.2   $ 44,973  

Percentage of revenue

     74.3       72.8

EMEA

   $ 19,266       69.8   $ 11,348  

Percentage of revenue

     19.1       18.4

APAC

   $ 6,649       21.3   $ 5,482  

Percentage of revenue

     6.6       8.8
  

 

 

     

 

 

 

Total revenue

   $ 100,638       62.8   $ 61,803  
  

 

 

     

 

 

 

 

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Revenue for the three months ended April 1, 2018 increased 62.8% compared to the prior year period. The increase was primarily driven by the launch and continued rollout of our Arlo Pro 2 camera, which launched in the fourth quarter of fiscal 2017. We continued to experience robust demand for existing product categories which, combined with the launch and continued rollout of Arlo Pro 2, drove revenue growth across all geographic regions. Additionally, service revenue increased by $2.5 million, or 43.0%, for the three months ended April 1, 2018 compared to the prior year period.

Cost of Revenue and Gross Margin

The following table presents cost of revenue and gross margin for the periods indicated:

 

     Three Months Ended  
     April 1,
2018
    % Change     April 2,
2017
 
     (In thousands, except percentage data)  

Cost of revenue

   $ 71,585       57.5   $ 45,450  

Gross margin

     28.9       26.5

Cost of revenue increased for the three months ended April 1, 2018 due primarily to revenue growth compared to the prior year period.

Gross margin increased for the three months ended April 1, 2018 compared to the prior year period due primarily to higher revenue achievement and higher product margin attainment, substantially benefitting from the launch of our Arlo Pro 2 camera. The increased gross margin attainment was partially offset by higher provisions for sales returns and channel marketing promotion activities deemed to be a reduction of revenue increasing disproportionately compared to the prior year period.

Operating Expenses

Research and Development

The following table presents research and development expense for the periods indicated:

 

     Three Months Ended  
     April 1,
2018
     % Change     April 2,
2017
 
     (In thousands, except percentage data)  

Research and development expense

   $ 12,025        50.6   $ 7,984  

Research and development expense increased for the three months ended April 1, 2018 compared to the prior year period due to increases of $1.9 million in personnel-related expenses, of which $1.4 million was for employees specifically identifiable to Arlo and $0.5 million was for allocated personnel-related expenses, $1.7 million in corporate IT and facility overhead and $0.5 million in engineering projects and outside professional services. The increased expenditures on personnel-related expense, engineering projects and outside professional services were due to continuous investment in strategic focus areas, principally the expansion of our Arlo product offerings and services and the growth of our cloud platform capabilities.

Sales and Marketing

The following table presents sales and marketing expense for the periods indicated:

 

     Three Months Ended  
     April 1,
2018
     % Change     April 2,
2017
 
     (In thousands, except percentage data)  

Sales and marketing expense

   $ 11,212        96.0   $ 5,721  

 

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Sales and marketing expense increased for the three months ended April 1, 2018 compared to the prior year period, primarily due to an increase in personnel-related expenses of $2.9 million, outside professional services of $1.1 million, marketing expenditures of $0.7 million, IT and facility overhead of $0.5 million and sales freight out expenses of $0.3 million. The increase in allocated personnel-related expenses and marketing expenditures resulted from the revenue increase described above. The majority of the costs incurred represented allocations from NETGEAR.

General and Administrative

The following table presents general and administrative expense for the periods indicated:

 

     Three Months Ended  
     April 1,
2018
     % Change     April 2,
2017
 
     (In thousands, except percentage data)  

General and administrative expense

   $ 4,878        77.7   $ 2,745  

General and administrative expense increased for the three months ended April 1, 2018 compared to the prior year period primarily due to higher allocated personnel-related expenditures of $1.3 million, legal and professional services of $0.4 million and IT and facility overhead of $0.4 million.

Separation Expense

The following table presents separation expense for the periods indicated:

 

     Three Months Ended  
     April 1,
2018
     % Change     April 2,
2017
 
     (In thousands, except percentage data)  

Separation expense

   $ 6,557                 **    $ —    

 

** Percentage change not meaningful.

Separation expense consists primarily of charges for third-party advisory, consulting, legal and professional services, IT-related expenses, and other items that are incremental and one-time in nature related to our separation from NETGEAR. We had no separation expense in the prior year period.

Other Income (Expense), Net

The following table presents other income (expense), net for the periods indicated:

 

     Three Months Ended  
     April 1,
2018
     % Change     April 2,
2017
 
     (In thousands, except percentage data)  

Other income (expense), net

   $ 575        69.1   $ 340  

Other income (expense), net increased for the three months ended April 1, 2018 compared to the prior year period due primarily to higher foreign currency transaction gains, primarily as a result of the U.S. dollar weakening versus transaction currencies.

 

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Provision for Income Taxes

 

     Three Months Ended  
     April 1,
2018
    % Change     April 2,
2017
 
     (In thousands, except percentage
data)
 

Provision for income taxes

   $ 319       45.7   $ 219  

Effective tax rate

     (6.3 )%        90.1

The increase in tax expense for the three months ended April 1, 2018 compared to the prior year period primarily resulted from improved earnings in foreign jurisdictions. Additionally, on December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Act. We do not anticipate an increase in tax expense from the Tax Act during the current period due to current year losses and loss carryforwards, previously subject to a valuation allowance, that can offset this income.

Comparison of the Fiscal Year Ended 2017 and 2016

Revenue by Geographic Region

We conduct business across three geographic regions: Americas, EMEA and APAC. We generally base revenue by geography on the ship-to location of the customer for device sales and device location for service sales.

 

     Year Ended December 31,  
     2017     % Change     2016  
     (In thousands, except percentage data)  

Americas

   $ 292,671       97.5   $ 148,164  

Percentage of revenue

     79.0       80.3

EMEA

   $ 58,795       114.1   $ 27,457  

Percentage of revenue

     15.9       14.9

APAC

   $ 19,192       113.6   $ 8,983  

Percentage of revenue

     5.1       4.8
  

 

 

     

 

 

 

Total revenue

   $ 370,658       100.8   $ 184,604  
  

 

 

     

 

 

 

Revenue increased 100.8% for the year ended December 31, 2017 compared to the prior year. The expansion of our sales channels, the rapid expansion of the consumer network connected camera systems market, the continued sales of our Arlo Pro camera launched in the third quarter of 2016 and the launch of our Arlo Pro 2 camera in the fourth quarter of fiscal 2017 contributed significantly to the revenue increase. Additionally, revenue further benefited from an increase in paid subscription service revenue due to the increase in the number of our registered users.

Cost of Revenue and Gross Margin

The following table presents cost of revenue and gross margin for the periods indicated:

 

     Year Ended December 31,  
     2017     % Change     2016  
     (In thousands, except percentage data)  

Cost of revenue

   $ 279,424       90.6   $ 146,570  

Gross margin

     24.6       20.6

Cost of revenue increased for the year ended December 31, 2017 due primarily to revenue growth compared to the prior year.

 

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Gross margin increased for the year ended December 31, 2017 compared to the prior year. The improvement in gross margin was achieved by effective product cost reduction and growth in paid subscription service revenue compared to the prior year.

Operating Expenses

Research and Development

The following table presents research and development expense for the periods indicated:

 

     Year Ended December 31,  
     2017      % Change     2016  
     (In thousands, except percentage data)  

Research and development expense

   $ 34,683        41.9   $ 24,438  

Research and development expense increased for the year ended December 31, 2017 compared to the prior year due to increases of $5.2 million in allocated personnel-related expense, $3.5 million in corporate IT and facility overhead and $1.6 million in engineering projects and outside professional services. The increased expenditures on personnel-related expense, engineering projects and outside professional services were due to continuous investment in strategic focus areas, such as to expand our Arlo product offerings and services and to grow our cloud platform capabilities.

Sales and Marketing

The following table presents sales and marketing expense for the periods indicated:

 

     Year Ended December 31,  
     2017      % Change     2016  
     (In thousands, except percentage data)  

Sales and marketing expense

   $ 34,340        86.1   $ 18,455  

Sales and marketing expense increased for the year ended December 31, 2017 compared to the prior year primarily due to an increase in personnel-related expenditures of $6.8 million, marketing expenditures of $5.4 million, outside professional services of $1.3 million, IT and facility overhead of $1.3 million and sales freight out expense of $1.0 million. The increase in allocated personnel and marketing expenditures resulted from the revenue increase described above. The majority of the costs incurred represented allocations from NETGEAR.

General and Administrative

The following table presents general and administrative expense for the periods indicated:

 

     Year Ended December 31,  
     2017      % Change     2016  
     (In thousands, except percentage data)  

General and administrative expense

   $ 15,096        82.1   $ 8,289  

General and administrative expense increased for the year ended December 31, 2017 compared to the prior year, primarily due to higher allocated personnel-related expenditures of $3.5 million, legal and professional services of $1.7 million, and IT and facility overhead of $1.3 million.

 

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Separation Expense

The following table presents separation expense for the periods indicated:

 

     Year Ended December 31,  
     2017      % Change     2016  
     (In thousands, except percentage data)  

Separation expense

   $ 1,384                 **    $ —    

 

** Percentage change not meaningful.

Separation expense consists primarily of charges for third-party advisory, consulting, legal and professional services, IT-related expenses, and other items that are incremental and one-time in nature related to our separation from NETGEAR. We had no separation expense in the prior year period.

Other Income (Expense), Net

The following table presents other income (expense), net for the periods indicated:

 

     Year Ended December 31,  
     2017      % Change     2016  
     (In thousands, except percentage data)  

Other income (expense), net

   $ 1,946                 **    $ (512

 

** Percentage data not meaningful

Other income (expense), net increased for the year ended December 31, 2017 compared to the prior year, due primarily to higher foreign currency transaction gains, primarily as a result of the U.S. dollar weakening versus transaction currencies.

Provision for Income Taxes

 

     Year Ended December 31,  
     2017     % Change     2016  
     (In thousands, except percentage data)  

Provision for income taxes

   $ 1,128                **    $ 83  

Effective tax rate

     14.7       (0.6 )% 

 

** Percentage data not meaningful

The increase in tax expense for the year ended December 31, 2017 compared to the prior year, primarily resulted from improved earnings in foreign jurisdictions. Additionally, on December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Act. The Tax Act resulted in an increase in tax expense, which was offset by the utilization of net operating losses and foreign tax credits that were previously subject to a valuation allowance.

Quarterly Financial Data

The following table sets forth selected unaudited historical quarterly combined statements of operations data for each of the eight quarterly periods ended December 31, 2017. The information for each of these quarters has been prepared on the same basis as the audited annual combined financial statements appearing elsewhere in this prospectus and, in our opinion, includes all adjustments, consisting only of normal recurring adjustments, necessary for the fair statement of the results of operations for these periods. This information should be read in

 

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conjunction with our audited combined financial statements and related notes appearing elsewhere in the prospectus. These quarterly results are not necessarily indicative of our operating results for a full year or any future period.

 

    December 31,
2017
    October 1,
2017
    July 2,
2017
    April 2,
2017
    December 31,
2016
    October 2,
2016
    July 3,
2016
    April 3,
2016
 
    (in thousands)  

Revenue

  $ 124,774     $ 104,887     $ 79,194     $ 61,803     $ 74,336     $ 46,651     $ 39,481     $ 24,136  

Gross profit

  $ 29,817     $ 28,352     $ 16,712     $ 16,353     $ 11,859     $ 11,095     $ 10,921     $ 4,159  

Total operating expenses

  $ 27,124     $ 22,609     $ 19,320     $ 16,450     $ 16,430     $ 13,653     $ 11,729     $ 9,370  

Income (loss) from operations

  $ 2,693     $ 5,743     $ (2,608   $ (97   $ (4,571   $ (2,558   $ (808   $ (5,211

Net income (loss)

  $ 2,663     $ 6,014     $ (2,153   $ 25     $ (5,095   $ (2,465   $ (1,126   $ (5,057

Quarterly Trends

Our quarterly revenue and gross profit increased sequentially generally for most of the periods presented, primarily due to increases in the number of devices sold, which was the result of new product introductions since December 2014, rapid expansion of our sales channel, including growth in international sales, and our consumer network connected camera systems market, and growth in service revenue. Generally, we have experienced the highest levels of revenue in the fourth quarter of the year compared to other quarters due in large part to seasonal holiday demand.

Quarterly operating expenses generally increased sequentially for all periods presented, primarily due to the increase of personnel-related expenses from increases in headcount and marketing and advertising expenses from our efforts to increase sales of our products and services.

Overall operating results fluctuate from quarter to quarter as a result of a variety of factors, including seasonal factors and economic cycles that influence consumer retail product purchase trends.

Liquidity and Capital Resources

Historically, our operations have participated in cash management and funding arrangements managed by NETGEAR. Cash flows related to financing activities primarily reflect changes in Net parent investment. Other than those that are in Arlo designated legal entities, NETGEAR’s cash has not been assigned to us for any of the periods presented because those cash balances are not directly attributable to us. Cash and cash equivalents presented in the combined balance sheets represent amounts pertaining to designated Arlo legal entities only. Our cash and cash equivalents balance increased from $0.1 million as of December 31, 2017 to $0.2 million as of April 1, 2018. Cash generated from operations was $25.4 million for the three months ended April 1, 2018, compared with cash used in operations of $11.4 million for the three months ended April 2, 2017, due primarily to lower working capital requirements. Cash used from operations increased from $33.1 million for the year ended December 31, 2016 to $39.0 million for the year ended December 31, 2017 due primarily to increased working capital demands. Currently, we are dependent on NETGEAR for our continued support to fund our operations, without which we would need to curtail our operations. NETGEAR intends to contribute $70.0 million in cash to us in the period leading up to the separation, a portion of which we may use prior to the separation for operating expenses, working capital and other requirements. Accordingly, the actual amount of cash that we may have immediately prior to the offering may be less than $70.0 million. In addition, NETGEAR currently intends to use reasonable efforts to provide us such funding as may be necessary to permit us to fund our operations while we are a wholly owned subsidiary of NETGEAR. This support is expected to terminate on the earliest of (i) September 1, 2019, (ii) the time immediately prior to the completion of this offering and

 

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(iii) the time immediately prior to the completion of a distribution of shares of our common stock held by NETGEAR to its stockholders.

Following the separation from NETGEAR, our capital structure and sources of liquidity will change significantly from our historical capital structure. Subsequent to the separation, we will no longer participate in cash management and funding arrangements managed by NETGEAR. Following the separation, we expect to use cash flows generated from operations, together with $70.0 million in cash contributed by NETGEAR on separation and our estimated net proceeds of approximately $173.1 million from the sale of our common stock in this offering (refer to “Use of Proceeds” for the expected use of such net proceeds), as our primary sources of liquidity. Based on our current plans and market conditions, we believe that such sources of liquidity will be sufficient to satisfy our anticipated cash requirements for at least the next 12 months. However, we may require or desire additional funds to support our operating expenses and capital requirements or for other purposes, such as acquisitions, and may seek to raise such additional funds through public or private equity or debt financing or from other sources. We cannot assure you that additional financing will be available at all or that, if available, such financing would be obtainable on terms favorable to us and would not be dilutive. Our future liquidity and cash requirements will depend on numerous factors, including the introduction of new products and potential acquisitions of related businesses or technology.

Cash Flow

The following table presents our cash flows for the periods presented.

 

    Three Months Ended     Year Ended December 31,  
    April 1,
2018
    April 2,
2017
    2017      2016  
   

(In thousands)

 

Net cash provided by (used in) operating activities

  $ 25,390     $ (11,364   $ (38,985    $ (33,070

Net cash used in investing activities

    (410     (1,868     (4,315      (10,289

Net cash provided by (used in) financing activities

    (24,910     13,138       43,188        43,579  
 

 

 

   

 

 

   

 

 

    

 

 

 

Net cash increase (decrease)

  $ 70     $ (94   $ (112    $ 220  
 

 

 

   

 

 

   

 

 

    

 

 

 

Net cash provided by operating activities was $25.4 million for the three months ended April 1, 2018 due primarily to lower working capital requirements. Working capital was primarily impacted by decreases to accounts receivable, offset by increases to inventory and decreases to accrued liabilities. Our days sales outstanding (“DSO”) decreased to 92 days as of April 1, 2018 as compared to 115 days as of December 31, 2017. Typically, DSO in the fourth quarter is higher due to seasonal payment terms provided to our larger customers. New to our DSO calculation is the negative impact of the adoption of ASU 2014-09, “Revenue from Contracts with Customers,” as of January 1, 2018. We calculated an eight day increase under the new revenue standard compared to the old revenue standard, mainly as a result of changes in the balance sheet presentation of certain reserve balances previously shown net within accounts receivable which are now presented as liabilities. Refer to Note 2, Revenue Recognition, in the Notes to Combined Financial Statements for the details on adoption impacts. Inventory was $103.8 million with ending inventory turns of 2.8 in the three months ended April 1, 2018 down from 4.6 turns in the three months ended December 31, 2017. Net cash used in investing activities was $0.4 million for the three months ended April 1, 2018 as a result of capital expenditures. Net cash used in financing activities primarily consisted of net investment to NETGEAR.

Net cash used in operating activities was $11.4 million for the three months ended April 2, 2017 due primarily to increased working capital demands. Working capital was primarily impacted by increases to inventory and decreases to accounts payable and accrued liabilities, offset by decreases to accounts receivable. Our DSO was 91 days as of April 2, 2017, which decreased from 99 days as of December 31, 2016. DSO as of

 

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December 31, 2016 was higher due to seasonal payment terms extended to our larger customers. Our accounts payable decreased from $21.1 million at December 31, 2016 to $8.2 million at April 2, 2017. The decrease was primarily attributable to timing of payments. Inventory was $67.3 million with ending inventory turns of 2.7, down from 5.2 turns in the three months ended December 31, 2016. Net cash used in investing activities was $1.9 million for the three months ended April 2, 2017 primarily from our capital expenditures and a $0.8 million payment in connection with our Placemeter acquisition. Net cash provided by financing activities primarily was the net investment from NETGEAR, as cash and the financing of our operations have historically been managed by NETGEAR. These transactions were deemed to be effectively settled for cash at the time the transaction was recorded.

Net cash used in operating activities was $39.0 million for the year ended December 31, 2017 due primarily to increased working capital demands. Working capital was primarily impacted by increases to accounts receivable and inventory, offset by increases to accrued liabilities. DSO increased by 16 days to 115 days as of December 31, 2017 due primarily to timing of gross shipments and seasonal payment terms with certain customers. Inventory was $83.0 million as of December 31, 2017 with ending inventory turns of 4.6 in the fourth quarter of 2017. Net cash used in investing activities was $4.3 million for the year ended December 31, 2017 primarily as a result of capital expenditures of $3.6 million. Net cash provided by financing activities primarily was the net investment from NETGEAR, as cash and the financing of our operations have historically been managed by NETGEAR. These transactions were deemed to be effectively settled for cash at the time the transaction was recorded.

Net cash used in operating activities was $33.1 million for the year ended December 31, 2016 due primarily to increased working capital demands. Working capital was primarily impacted by increases to accounts receivable and inventory, offset by increases to accounts payable and accrued liabilities. DSO was 99 days as of December 31, 2016 due primarily to timing of gross shipments and seasonal payment terms with certain customers. Inventory turns were 5.2 in the fourth quarter of 2016. Net cash used in investing activities was $10.3 million for the year ended December 31, 2016, primarily as a result of the acquisition of Placemeter, Inc., a computer vision analytics company, for $8.8 million. Net cash provided by financing activities primarily was the net investment from NETGEAR, as cash and the financing of our operations have historically been managed by NETGEAR. These transactions were deemed to be effectively settled for cash at the time the transaction was recorded.

Backlog

Our backlog consists of products for which customer purchase orders have been received and that are scheduled or in the process of being scheduled for shipment. As of December 31, 2017, we had a backlog of $15.6 million, compared to $14.2 million as of December 31, 2016. As we typically fulfill orders received within a relatively short period (e.g., within one week for our top three customers) after receipt, our revenue in any fiscal year depends primarily upon orders booked and the availability of supply of our products in that year. In addition, most of our backlog is subject to rescheduling or cancellation with minimal penalties. As a result, our backlog as of any particular date may not be an indicator of revenue for any succeeding period. Similarly, there is a lack of meaningful correlation between year-over-year changes in backlog as compared with year-over-year changes in revenue. Accordingly, we do not believe that backlog information is material to an understanding of our overall business, and backlog as of any particular date should not be considered a reliable indicator of our ability to achieve any particular level of revenue or financial performance.

Contractual Obligations

The following table summarizes our non-cancelable purchase obligations as of December 31, 2017:

 

     Total      Less Than
1 Year
     1-3
Years
     3-5
Years
     More Than
5 Years
 
     (In thousands)  

Purchase obligations

   $ 54,302      $ 54,302      $ —        $ —        $ —    

 

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We enter into various inventory-related purchase agreements with suppliers. Generally, under these agreements, 50% of the orders are cancelable by giving notice 46 to 60 days prior to the expected shipment date and 25% of orders are cancelable by giving notice 31 to 45 days prior to the expected shipment date. Orders are not cancelable within 30 days prior to the expected shipment date. As of April 1, 2018 and December 31, 2017, we had $36.4 million and $54.3 million in non-cancelable purchase commitments with suppliers, respectively. We expect to sell all products for which we have committed purchases from suppliers.

As of December 31, 2017, we did not estimate any long-term liability related to a one-time transaction tax that resulted from the passage of the Tax Act. We had significant net operating losses and credits that were available to shelter a majority of the impact associated with the transition tax.

As of April 1, 2018 and December 31, 2017, we had $1.3 million and $1.0 million, respectively, of total gross unrecognized tax benefits and related interest and penalties. The timing of any payments that could result from these unrecognized tax benefits will depend upon a number of factors. The unrecognized tax benefits have been excluded from the contractual obligations table because reasonable estimates cannot be made of whether, or when, any cash payments for such items might occur. We do not expect to reduce our liabilities for uncertain tax positions in any jurisdiction, where the impact would affect the statement of operations, in the next 12 months.

Off-Balance Sheet Arrangements

As of April 1, 2018 and December 31, 2017 and 2016, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

Critical Accounting Policies and Estimates

Our combined financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and pursuant to the regulations of the U.S. Securities and Exchange Commission (“SEC”). The preparation of these condensed combined financial statements requires management to make assumptions, judgments and estimates that can have a significant impact on the reported amounts of assets, liabilities, revenue and expenses. We base our estimates on historical experience and on various other assumptions believed to be applicable and reasonable under the circumstances. Actual results could differ significantly from these estimates. These estimates may change as new events occur, as additional information is obtained and as our operating environment changes. On a regular basis, we evaluate our assumptions, judgments and estimates and make changes accordingly. We also discuss our critical accounting estimates with the Audit Committee of the Board of Directors. Note 1, The Company, Basis of Presentation and Summary of Significant Accounting Policies, in Notes to Combined Financial Statements describes the significant accounting policies used in the preparation of the combined financial statements. We have listed below our critical accounting policies that we believe to have the greatest potential impact on our combined financial statements.

Adoption of ASU 2014-09, “Revenue from Contracts with Customers” (Topic 606)

On January 1, 2018, we adopted ASU 2014-09, “Revenue from Contracts with Customers” (Topic 606) (“ASC 606”) and applied this guidance to those contracts which were not completed at the date of adoption using the modified retrospective method. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods (ASC 605). Refer to Note 2, Revenue Recognition, in Notes to Combined Financial Statements, for accounting policies relating to revenue recognition which replace the below policies in effect for periods prior to January 1, 2018. The adoption of ASC 606 affected the following policies of Revenue Recognition, Allowances for Warranty Obligations and Returns due to Stock Rotation and Sales Incentives upon the adoption of ASC 606.

 

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Revenue Recognition

We generally recognize revenue from product sales at the time the product is shipped, provided that persuasive evidence of an arrangement exists, title and risk of loss have transferred to the customer, the selling price is fixed or determinable and collection of the related receivable is reasonably assured. Currently, for some of our customers, title passes to the customer upon delivery to the port or country of destination, upon their receipt of the product, or upon the customer’s resale of the product. At the end of each fiscal quarter, we estimate and defer revenue related to product where title has not transferred. The revenue continues to be deferred until such time that title passes to the customer. We assess collectability based on a number of factors, including general economic and market conditions, past transaction history with the customer and the creditworthiness of the customer. If we determine that collection is not reasonably assured, then we defer revenue until receipt of the payment from the customer.

A large majority of our product offerings consist of multiple elements. Our multiple-element product offerings include hardware with bundled prepaid services, which are considered separate units of accounting. In general, the hardware is delivered up-front, while the bundled prepaid services are delivered over the stated service period, or the estimated useful life. We allocate revenue to the deliverables based upon their relative selling price. We recognize revenue allocated to each unit of accounting when persuasive evidence of an arrangement exists, title and risk of loss have transferred to the customer, the selling price is fixed or determinable and collection of the related receivable is reasonably assured.

When applying the relative selling price method, we determine the selling price for each deliverable using vendor-specific objective evidence (“VSOE”) of fair value of the deliverable, or when VSOE of fair value is unavailable, our best estimate of selling price (“ESP”), as we have determined that we are unable to establish third-party evidence of selling price for the deliverables. In determining VSOE, we require that a substantial majority of the selling prices for a deliverable sold on a stand-alone basis fall within a reasonably narrow pricing range, generally evidenced by approximately 80% of such historical stand-alone transactions falling within +/-15% of the median price. We determine ESP for a deliverable by considering multiple factors including, but not limited to, market conditions, competitive landscape, internal costs, gross margin objectives and pricing practices. The objective of ESP is to determine the price at which we would transact a sale if the deliverable were sold on a stand-alone basis. The determination of ESP is made through consultation with and formal approval by our management, taking into consideration the go-to-market strategy.

Allowances for Warranty Obligations and Returns due to Stock Rotation

Our standard warranty obligation to our direct customers generally provides for a right of return of any product for a full refund in the event that such product is not merchantable or is found to be damaged or defective. At the time we recognize revenue, we record an estimate of future warranty returns to reduce revenue in the amount of the expected credit or refund to be provided to our direct customers. At the time we record the reduction to revenue related to warranty returns, we include within cost of revenue a write-down to reduce the carrying value of such products to net realizable value. Our standard warranty obligation to end-users provides for replacement of a defective product for one or more years. Factors that affect the warranty obligation include product failure rates, material usage and service delivery costs incurred in correcting product failures. We record the estimated cost associated with fulfilling the warranty obligation to end-users in cost of revenue. Because our products are manufactured by third-party manufacturers, in certain cases we have recourse to the third-party manufacturer for replacement or credit for the defective products. We give consideration to amounts recoverable from our third-party manufacturers in determining our warranty liability. Our estimated allowances for product warranties can vary from actual results, and we may have to record additional revenue reductions or charges to cost of revenue, which could materially impact our financial position and results of operations.

In addition to warranty-related returns, certain distributors and retailers generally have the right to return product for stock rotation purposes. Upon shipment of the product, we reduce revenue by an estimate of potential

 

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future stock rotation returns related to the current period product revenue. We analyze historical returns, channel inventory levels, current economic trends and changes in customer demand for our products when evaluating the adequacy of the allowance for stock rotation returns. Our estimated allowances for returns due to stock rotation can vary from actual results, and we may have to record additional revenue reductions, which could materially impact our financial position and results of operations.

Sales Incentives

We accrue for sales incentives as a marketing expense if we receive an identifiable benefit in exchange and can reasonably estimate the fair value of the identifiable benefit received; otherwise, we record sales incentives as a reduction of revenue. Our estimated provisions for sales incentives can vary from actual results, and we may have to record additional expenses or additional revenue reductions dependent on the classification of the sales incentive.

Allowances for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We regularly perform credit evaluations of our customers’ financial condition and consider factors, such as historical experience, credit quality, age of the accounts receivable balances and geographic or country-specific risks and economic conditions, that may affect a customer’s ability to pay. We review the allowance for doubtful accounts quarterly and adjust it if necessary based on our assessments of our customers’ ability to pay. If the financial condition of our customers should deteriorate or if actual defaults are higher than our historical experience, additional allowances may be required, which could have an adverse impact on operating expenses.

Valuation of Inventory

We value our inventory at the lower of cost or net realizable value, cost being determined using the first-in, first-out method. We continually assess the value of our inventory and will periodically write down its value for estimated excess and obsolete inventory based upon assumptions about future demand and market conditions. On a quarterly basis, we review inventory quantities on hand and on order under non-cancelable purchase commitments, in comparison to our estimated forecast of product demand for the next nine months to determine what inventory, if any, is not saleable. We base our analysis on the demand forecast but take into account market conditions, product development plans, product life expectancy and other factors. Based on this analysis, we write down the affected inventory value for estimated excess and obsolescence charges. At the point of loss recognition, a new, lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. As demonstrated during prior years, demand for our products can fluctuate significantly. If actual demand is lower than our forecasted demand and we fail to reduce our manufacturing accordingly, we could be required to write down the value of additional inventory, which would have a negative effect on our gross profit.

Goodwill

Goodwill attributed to Arlo pertained to the acquisitions of Avaak, Inc. (“Avaak”) and Placemeter, Inc. (“Placemeter”). Goodwill represents the purchase price over estimated fair value of net assets of businesses acquired in a business combination. Goodwill acquired in a business combination is not amortized, but instead tested for impairment at least annually on the first day of the fourth quarter. Should certain events or indicators of impairment occur between annual impairment tests, we will perform the impairment test as those events or indicators occur. Examples of such events or circumstances include: a significant decline in our expected future cash flows, a sustained, significant decline in our stock price and market capitalization, a significant adverse change in the business climate and slower growth rates.

 

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Starting from the fourth fiscal quarter of 2017, we early adopted ASU 2017-04, “Intangibles-Goodwill and Other: Simplifying the Test for Goodwill Impairment.”

We test goodwill for impairment at the reporting unit level by first performing a qualitative assessment to determine whether it is more likely than not (that is, a likelihood of more than 50%) that the fair value of the reporting unit is less than its carrying value. The qualitative assessment considers: macroeconomic conditions, industry and market considerations, cost factors, overall company financial performance, events affecting the reporting units and changes in our share price. If the reporting unit does not pass the qualitative assessment, we estimate its fair value and compare the fair value with the carrying value of the reporting unit, including goodwill. If the fair value is greater than the carrying value of the reporting unit, we do not record an impairment. If the fair value is less than the carrying value, we recognize an impairment loss for the amount that the carrying amount of a reporting unit, including goodwill, exceeds its fair value, limited to the total amount of goodwill allocated to that reporting unit. We would record the impairment charge to earnings in the combined statements of operations.

We completed the annual impairment test of goodwill as of the first day of the fourth fiscal quarter of 2017 and 2016, or October 2, 2017 and October 3, 2016. We identified that we have one reporting unit for the purpose of goodwill impairment testing, and the reporting unit is at the same level as our operating segment and reportable segment. We performed a qualitative test for goodwill impairment for the years ended December 31, 2017 and 2016. Based upon the results of the qualitative testing, the fair value was substantially in excess of the carrying value. We believe that it is more likely than not that the fair value is greater than its carrying value and therefore performing the next step of impairment test was unnecessary. We therefore did not recognize any goodwill impairment for the years ended December 31, 2017 and 2016.

We do not believe it is likely that there will be a material change in the estimates or assumptions we use to test for impairment loss on goodwill. However, if the actual result is not consistent with our estimates or assumptions, we may be exposed to an impairment charge that could be material.

Long-Lived Assets Excluding Goodwill

Our long-lived assets include goodwill, purchased intangibles with finite lives and property and equipment. Intangibles, net attributed to Arlo pertained to the acquisitions of Avaak and Placemeter. We amortize purchased intangibles with finite lives using the straight-line method over the estimated economic lives of the assets, which range from three to five years. We state property and equipment at historical cost, less accumulated depreciation. We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Examples of such events or circumstances include: a significant decrease in the market price of the asset, a significant decline in our expected future cash flows, significant changes or planned changes in our use of the assets and a significant adverse change in the business climate. We base our determination of recoverability on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. If the carrying amount of the asset exceeds its estimated undiscounted future net cash flows, we recognize an impairment charge in the amount by which the carrying amount of the asset exceeds the fair value of the asset. We review the carrying value of the asset on a regular basis for the existence of facts, both internal and external, that may suggest impairment.

For the years ended December 31, 2017 and 2016, there were no events or changes in circumstances that indicated the carrying amount of our finite-lived assets may not be recoverable from their undiscounted cash flows. Consequently, we did not perform an impairment test. We also reviewed the depreciation and amortization policies for the long-lived asset groups and ensured the remaining useful lives are appropriate. We did not record any impairments to intangibles for the years ended December 31, 2017 and 2016. We review the carrying value of property and equipment assets on a regular basis for the existence of facts, both internal and external, that may suggest impairment. Charges related to the impairment of property and equipment were insignificant for the years ended December 31, 2017 and 2016.

 

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We will continue to evaluate the carrying value of our long-lived assets, and if we determine in the future that there is a potential further impairment, we may be required to record additional charges to earnings, which could affect our financial results.

Income Taxes

The operations of our business have been included in the consolidated U.S. federal income tax return and certain foreign income tax returns of NETGEAR. The income tax provisions and related deferred tax assets and liabilities that have been reflected in our historical combined financial statements have been estimated as if we were a separate taxpayer. We are subject to taxation in all geographies in which we operate, and as a stand-alone entity, will file tax returns in each jurisdiction in which we operate. We record a provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities, as well as for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. Our assessment considers the recognition of deferred tax assets on a jurisdictional basis. Accordingly, in assessing our future taxable income on a jurisdictional basis, we consider the effect of its transfer pricing policies on that income. We have placed a valuation allowance against U.S. federal and state deferred tax assets since the recovery of the assets is uncertain.

We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. As we expand internationally, we will face increased complexity in determining the appropriate tax jurisdictions for revenue and expense items which may differ from that of NETGEAR. Our policy is to adjust these reserves when facts and circumstances change, such as the closing of a tax audit or refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made and could have a material impact on our financial condition and operating results. The provision for income taxes includes the effects of any accruals that we believe are appropriate, as well as the related net interest and penalties.

On December 22, 2017, the Tax Act was signed into law, making significant changes to the Code. Changes include, but are not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years beginning after December 31, 2017, the transition of U.S. international taxation from a worldwide tax system to a territorial system, and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings. The recently enacted Tax Act significantly changed how the United States taxes corporations. At this time, significant judgment is required in implementing the law due to the lack of sufficient interpretive guidance from the U.S. or state regulatory bodies and standards settings bodies. Computations required are complex and data-intensive. The amounts reported as of December 31, 2017, are provisional based on the uncertainty discussed above. As guidance becomes available, we will adjust our calculations and provisional amounts that we have recorded in our tax provision.

Recent Accounting Pronouncements

For a complete description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on financial condition and results of operations, refer to Note 1, The Company, Basis of Presentation and Summary of Significant Accounting Policies, in Notes to Combined Financial Statements.

 

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Emerging Growth Company Status

As an “emerging growth company,” under the JOBS Act, we are allowed to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies, unless we otherwise irrevocably elect not to avail ourselves of this exemption. While we have not made such an irrevocable election, we have not delayed the adoption of any applicable accounting standards.

Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Exchange Rate Risk

We invoice some of our international customers in foreign currencies, including the Australian dollar, British pound, Canadian dollar and Euro. As the customers that are currently invoiced in local currency become a larger percentage of our business, or to the extent we begin to bill additional customers in foreign currencies, the impact of fluctuations in foreign currency exchange rates could have a more significant impact on our results of operations. For those customers in our international markets that we continue to sell to in U.S. dollars, an increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and therefore reduce the demand for our products. Such a decline in the demand for our products could reduce sales and materially adversely affect our business, results of operations and financial condition. Certain operating expenses of our foreign operations require payment in local currencies.

We are exposed to risks associated with foreign exchange rate fluctuations due to our international sales and operating activities. These exposures may change over time as business practices evolve and could negatively impact our operating results and financial condition. As we grow our operations, our exposure to foreign currency risk could become more significant. To date, we have not entered into any foreign currency exchange contracts and currently do not expect to enter into foreign currency exchange contracts for trading or speculative purposes. We plan to establish a hedge program to hedge foreign currency exchange risks after the distribution, if not before.

As of December 31, 2017, we had net assets in various local currencies. A hypothetical 10% movement in foreign exchange rates would result in a before-tax positive or negative impact of $3.4 million on net income at December 31, 2017. Actual future gains and losses associated with our foreign currency exposures and positions may differ materially from the sensitivity analyses performed as of December 31, 2017 due to the inherent limitations associated with predicting the foreign currency exchange rates and our actual exposures and positions. For the year ended December 31, 2017, 23.7% of revenue was denominated in a currency other than the U.S. dollar.

 

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BUSINESS

Overview

Arlo combines an intelligent cloud infrastructure and mobile app with a variety of smart connected devices that transform the way people experience the connected lifestyle. Our cloud-based platform creates a seamless, end-to-end connected lifestyle solution that provides users visibility, insight and a powerful means to help protect and connect with the people and things that matter most to them. Arlo enables users to monitor their environments and engage in real-time with their families and businesses from any location with a Wi-Fi or a cellular network internet connection. To date, we have launched several categories of award-winning smart connected devices, including wire-free smart Wi-Fi and LTE-enabled cameras, advanced baby monitors and smart security lights. In addition, Arlo’s broad compatibility allows the platform to seamlessly integrate with third-party internet-of-things (“IoT”) products and protocols, such as Amazon Alexa, Apple HomeKit, Apple TV, Google Assistant, IFTTT, Stringify and Samsung SmartThings. Since the launch of our first product in December 2014, we have shipped over 7.5 million smart connected devices, and, as of April 1, 2018, our smart platform had over 1.9 million registered users across more than 100 countries around the world. We plan to continue to introduce new smart connected devices to the Arlo platform in new categories, increase the number of registered users on our platform, keep them highly engaged through our mobile app and generate incremental recurring revenue by offering them paid subscription services.

The proliferation of IoT devices, the commoditization of cloud infrastructure and the propagation of artificial intelligence (“AI”), coupled with consumers’ preference for a do-it-yourself (“DIY”) experience, are all driving the adoption of smart connected technology. Arlo exemplifies a new generation of smart IoT platforms by featuring smart devices that are always connected to the internet, software developed with AI capabilities, including machine learning and computer vision, and a highly engaging mobile app through which users can manage and utilize their smart connected devices. We believe we are well-positioned to capture this large and fast-growing market opportunity by leading the way into this new generation of connected lifestyle platforms.

Our total addressable market consists of individuals and business owners who use connected devices to enhance their lives. According to Gartner, consumer IoT endpoints hardware and services spending will reach $1.8 trillion by 2021.(1) Gartner estimates our addressable market for the global connected home alone, including elements of consumer IoT services spending and IoT endpoints hardware spending, will grow from $45 billion in 2017 to $146 billion in 2021, representing a compound annual growth rate (“CAGR”) of 34%.(2) Outside of the home, we have seen adoption of our cellular-enabled products in a variety of use cases, such as neighborhood watch, construction site monitoring, wildlife and outdoor trail surveillance and event monitoring. We are also seeing demand for our products and solutions from small businesses and local government agencies, and believe these segments represent additional growth areas for us.

A user’s introduction to our smart platform typically starts with the purchase of one or more of our cameras and lights. Consumers and business owners can easily set up these smart connected devices and integrate them into their homes and businesses without the need for professional installation services. To begin the setup of an Arlo device, users download the Arlo app, which functions as the single user interface for managing and utilizing all Arlo devices and is powered by our cloud infrastructure. The Arlo app provides users with a highly engaging experience through real-time motion detection notifications and live stream functionality that includes two way audio. To realize the platform’s full potential, users can subscribe to Arlo Smart, a paid subscription service that

 

(1)  Gartner, Forecast: Internet of Things—Endpoints and Associated Services, Worldwide, 2017, 21 December 2017, Table 4.1 (Home Automation/Other, Home Energy Management, Home Security and Safety) & 12.1 (Home Security and Safety, Home Automation, Energy Management, Other).
(2)  Gartner, Forecast: Internet of Things—Endpoints and Associated Services, Worldwide, 2017, 21 December 2017, Table 4.1 (Home Automation/Other, Home Energy Management, Home Security and Safety) & 12.1 (Home Security and Safety, Home Automation, Energy Management, Other).

 

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adds powerful AI capabilities to Arlo cameras that enhance the user experience. Arlo Smart provides users with intelligence and rich app notifications such as person-detection capabilities, e911 functionality and motion-zone customization. These Arlo Smart services are available via three subscription-based tiers: Arlo Smart Premier, Arlo Smart Elite and Arlo Smart Add-On, each more fully described below under —Arlo Services.”

 

LOGO

 

* Engagement rate measured by daily active users divided by monthly active users on iOS platform in the United States for the first quarter of 2018. Sensor Tower: Average daily active users and monthly active users on iOS platform in U.S. for the first quarter of 2018.

Our fully integrated smart platform provides an intuitive and engaging user experience, which distinguishes our product offerings and contributes to our rapid growth. According to Sensor Tower, for the first quarter of 2018, the Arlo app had a user engagement rate, measured by daily active users (the number of users who launch the Arlo app at least once per day on average in a period) divided by monthly active users (the number of users who launch the Arlo app at least once per month on average in a period), of 37%. Sensor Tower’s data also shows that, during the same period, the Arlo app’s number of daily active users was in line with the median of the 500 most downloaded apps from the Apple App Store and that the Arlo app had a user engagement rate in the top 6% of these apps. While not one of these 500 apps, the Arlo app’s user engagement rate compares favorably to many of the most engaging social media and entertainment apps available. We believe our high user engagement rate is driven by the combination of individuals’ inherent desire to stay close to what they value most and the high-quality user experience that our platform provides. Our high user engagement rate allows us to use the Arlo app as a highly effective marketing channel to introduce and promote our broad range of smart connected devices, accessories and our paid Arlo Smart services to our user base. We have also cultivated an online community that users access through our website, which we refer to as the Arlo Community, where users can share Arlo video content and give each other tips on using Arlo devices. In 2016 and 2017, the number of unique visitors to the Arlo Community website reached 1.0 million and 2.3 million, respectively.

We believe that the power of our platform increases as the number of users and devices on the platform grows. As our user base and community grow, more devices are connected to our platform, which enables us to analyze an increasing volume of data, and in turn facilitates more refined computer vision algorithms. We expect that these improving capabilities will enable us to offer more innovative and intelligent services and features to our users, who we believe will increasingly be willing to pay for subscription services to benefit from these capabilities. We believe that, as awareness of our platform grows, more users will seek to purchase both our smart connected devices and our Arlo Smart services and join our rapidly growing user base.

 

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LOGO

We believe that the combination of our leading technology and our decades of experience gained from operating within a highly successful consumer electronics company positions us well against the competition and to be successful as an independent company.

 

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LOGO

We have built the Arlo platform on three key technology differentiators:

 

    Radio Frequency (“RF”) Connectivity and Power Management Expertise. Our leading RF connectivity expertise, developed through nearly 20 years of research and development, enables whole home coverage via Wi-Fi and in remote areas via cellular networks and industry-leading time-to-first-frame (“TTFF”) performance to minimize lag between motion detection and video recording. Our proven power management expertise, leveraged from NETGEAR’s years of experience building mobile hotspots, encompasses hardware product design, software and firmware, including patented beaconing and power management methods, to prolong battery life.

 

    Product Design. Our aesthetically appealing, compact and weather-resistant industrial design has won multiple awards and provides our users the freedom and flexibility to place our products both inside and outside the home without professional installation services.

 

    Broad Compatibility. We purposefully designed Arlo products to have broad compatibility, allowing them to be integrated with leading third-party IoT products and protocols, such as Amazon Alexa, Apple HomeKit, Apple TV, Google Assistant, IFTTT, Stringify and Samsung SmartThings.

These differentiators, in combination with our scalable cloud infrastructure and AI-enabled features delivered in real-time through the Arlo app, have positioned Arlo to be the smart platform of choice for many consumers and businesses.

We benefit from NETGEAR’s decades of supply chain experience serving the dynamic and competitive retail industry. We also have leveraged its deep and long-standing relationships with leading channel partners such as Best Buy, Amazon, Costco and Walmart, Inc., major wireless carriers around the world such as AT&T, Verizon and Telstra, and more recently, broadcast channels such as HSN. Leveraging NETGEAR’s deep channel relationships and highly experienced supply chain team, Arlo has been able to position its products favorably across in-store retail, wireless carriers, and online distribution channels. We expect these relationships to continue in substantially the same manner once we become a stand-alone public company. As an operating segment of a seasoned public company, we benefit from established business processes and a veteran leadership

 

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team, allowing Arlo to focus its attention on growing and developing the business. While our history with NETGEAR has provided us with certain competitive advantages, we believe that the separation, this offering and the distribution will provide a number of additional benefits to our business. See the section titled “Certain Relationships and Related Party Transactions—Relationship with NETGEAR.”

We have experienced significant growth since the launch of our first product in December 2014, and according to NPD, for the second quarter of 2018, we held 48% market share based on dollar sales in the U.S. consumer network connected camera systems market.(3) Outside of the United States, we are the leader in Australia and several major European markets. In 2016, Arlo grew revenue by 108% over the prior year to $184.6 million, and in 2017, Arlo further grew revenue by 101% over the prior year to $370.7 million. For additional information regarding Arlo’s financial performance, see the section titled “Selected Combined Financial Data.”

Our Market Opportunity

Our total addressable market consists of individuals and business owners who use connected devices to enhance their lives. According to Gartner, consumer IoT end points hardware spending will reach $1.8 trillion by 2021.(4) Gartner estimates our addressable market for the global connected home alone, including elements of consumer IoT services spending and IoT endpoints hardware spending, will grow from $45 billion in 2017 to $146 billion in 2021, representing a CAGR of 34%.(5) Outside of the home, we have seen adoption of our cellular-enabled products in a variety of use cases, such as neighborhood watch, construction site monitoring, wildlife and outdoor trail surveillance and event monitoring. We believe the small business and government segments represent additional growth areas for us. According to the U.S. Small Business Administration, in 2016, there were 28.8 million small businesses in the United States, accounting for 99.7% of all U.S. businesses, and we believe we are well-positioned to benefit from this large market.

Our technology leadership, embodied in our smart platform, has helped us achieve significant market share gain in the consumer network connected camera systems market. According to NPD, for the second quarter of 2018, we held 48% market share based on dollar sales in the U.S. consumer network connected camera systems market,(6) and our market leadership extends to international markets where we have introduced our products. In addition to global expansion opportunities, we believe we are well-positioned to extend our current market leadership to the broader connected lifestyle market both within and beyond the home as we continue to launch new product lines and services within our connected lifestyle platform.

Key Trends Driving Our Market

The intersection of the following significant technology trends are driving mass adoption of a new generation of smart IoT connected lifestyle platforms.

 

(3) 

The NPD Group, Inc., U.S. Retail Weekly Tracking Service, Security & Monitoring, Camera technology: excludes baby monitors, Security camera system type: excludes not remote viewing ready, Brand: NETGEAR (Arlo), based on dollar sales, April 8, 2018 - July 7, 2018.

(4) 

Gartner, Forecast: Internet of Things — Endpoints and Associated Services, Worldwide, 2017, 21 December 2017, Table 4.1 (Home Automation/Other, Home Energy Management, Home Security and Safety) & 12.1 (Home Security and Safety, Home Automation, Energy Management, Other).

(5) 

Gartner, Forecast: Internet of Things — Endpoints and Associated Services, Worldwide, 2017, 21 December 2017, Table 4.1 (Home Automation/Other, Home Energy Management, Home Security and Safety) & 12.1 (Home Security and Safety, Home Automation, Energy Management, Other).

(6) 

The NPD Group, Inc., U.S. Retail Weekly Tracking Service, Security & Monitoring, Camera technology: excludes baby monitors, Security camera system type: excludes not remote viewing ready, Brand: NETGEAR (Arlo), based on dollar sales, April 8, 2018 - July 7, 2018.

 

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The Proliferation of IoT Devices. According to Gartner, there were eight billion consumer IoT endpoint installed base units in 2017, and this number is expected to reach 25 billion by 2021.(7) Gartner expects that consumer IoT endpoint unit installed base spending will be the largest segment, encompassing 64% of the market in 2021.(8) We believe the new generation of smart IoT platforms, like Arlo, will feature smart devices that are always connected to the cloud, AI-based services and mobile apps through which users can manage their connected devices, creating a highly engaging user experience.

Adoption of Cloud-Based Connectivity and Infrastructure. The public cloud services market is rapidly expanding and steadily evolving, strengthening its role as the foundation for digital business and consumer services. The public cloud services market is rapidly expanding and steadily evolving, strengthening its role as the foundation for digital business and consumer services. According to Gartner, public cloud services spending is expected to reach $302 billion by 2021 in current U.S. dollars, growing at a CAGR of 19% from 2016 to 2021.(9) Scalable public cloud computing infrastructure has allowed companies to innovate at a rapid pace and pass along the benefits to end-users in the form of intelligent and real-time services delivered at low cost and low latency. For example, Arlo stores videos captured by connected cameras that can then be viewed by users on demand, ensuring low upfront cost of ownership and on-demand scalability of video storage. As a result, consumers and business owners are rapidly adopting cloud-based smart connected lifestyle solutions that are increasingly efficient, accessible and user-friendly.

The Mobile Era. The universal adoption of smartphones and tablets has transformed the way people interact with each other and their environments. According to IDC, more than 1.6 billion smartphones and tablets were shipped in 2017. Today, mobile apps are a preferred method for users to manage various aspects of their lives. Having experienced this transformation, consumers are increasingly demanding a convenient and efficient mobile experience to drive today’s connected lifestyle.

Consumer Preference for a DIY Experience. DIY connected solutions — in which consumers and small business owners install and monitor the systems on their own — are in high demand. According to Parks Associates, 73% of smart home device owners said they installed the devices by themselves or with the help from friends and family members. Among users of home IoT devices, ease of installation and ease of use are the most sought after attributes according to IDC. Unlike Arlo, many Wi-Fi connected home systems today are not wire-free, requiring users to run power cords to their devices and in many cases requiring professional installation, especially in outdoor environments. Being wire-free and weather-resistant, Arlo’s devices provide users with increased flexibility to install smart connected devices both inside and outside of their homes and businesses. According to Gartner, consumers, device providers and service providers will assemble packages of home security devices, which will include cameras, motion sensors, burglar alarm control units, and door and window locks. Currently, the majority of these packages come from a service provider. But the tendency over time will be for consumers to “self-monitor” to a greater degree, reaching the point where most household security systems will be self-monitored.(10) Since the entire Arlo experience can be self-managed via the cloud and a smartphone app, users do not need to pay professional third-party service providers to manage and monitor their systems. As a result, our well-designed DIY products significantly reduce the cost of ownership and eliminate challenges of self-installation while increasing control and flexibility, thereby fueling demand for our user-friendly smart home platforms and devices.

Big Data Analytics and AI Adoption. According to IDC, the volume of information being processed and transferred globally is expected to reach 163ZB (trillion gigabytes) by 2025, a ten-fold increase compared to

 

(7)  Gartner, Forecast Analysis: Internet of Things — Endpoints, Worldwide, 2017 Update, 27 December 2017, Table 1.
(8)  Gartner, Forecast Analysis: Internet of Things — Endpoints, Worldwide, 2017 Update, 27 December 2017, Table 1: 2021 consumer data point divided by 2021 total data point.
(9)  Gartner, Forecast: Public Cloud Services, Worldwide, 2015-2021, 4Q17 Update, 15 January 2018, Table 1-1.
(10)  Gartner, Forecast Analysis: Internet of Things — Services, Worldwide, 2017 Update, 28 December 2017.

 

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2016. Unstructured video and image data streams are expected to represent the largest growth driver, as the global computer vision market is expected to reach $26 billion by 2025, growing at a CAGR of 42% from 2016 to 2025, according to Tractica. As more data is collected and processed, AI-enabled products and services are becoming more sophisticated and gaining mass adoption by consumers, leading to a smarter and more convenient lifestyle. According to IDC, widespread adoption of cognitive systems and AI across a broad range of industries will drive worldwide spending on AI and cognitive systems from nearly $12 billion in 2017 to $58 billion in 2021.

Safety and Security Are Top Use Cases in Connected Technology. According to Parks Associates, U.S. consumers view safety and security as one of the most important benefits of smart home systems. We believe the peace of mind arising from being connected is a powerful driver of consumer and small business purchasing behavior, promoting the rapid and continuing adoption of connected technology.

Our Competitive Advantages — What Sets Us Apart

Best-in-Class Technology. Our engineers continually push the boundaries of innovation to develop products that leverage our cutting-edge technological capabilities. We are committed to hiring and retaining top engineers and thought leaders in the field.

 

    RF Connectivity Expertise. Arlo wire-free cameras benefit from the nearly 20 years of RF connectivity expertise of NETGEAR. Such RF expertise extends across cellular, Wi-Fi and Bluetooth protocols, enabling low latency communication between Arlo devices and our back-end cloud infrastructure and allowing us to build connected products that have shorter TTFF, greater range and stronger connectivity than our principal competitors’ products. These strengths allow our users to place our smart connected devices in a wide variety of locations in and around their homes, businesses and elsewhere and still receive the excellent video quality the Arlo platform can provide.

 

    Power Management Expertise. Arlo’s power management expertise, encompassing hardware product design, software and firmware, minimizes power consumption in our devices. Motion-activated on/off sensors prolong the devices’ overall battery life, and our patented low-power Wi-Fi technology also minimizes battery usage before and during video transmission. As a result, our users typically only need to recharge their Arlo devices every three to six months, leading to flexible indoor and outdoor placement options.

 

    Product Design. Arlo products are designed to provide a user-friendly out-of-box experience for consumers. Our sleek wire-free design takes up minimal space and allows our products to be easily and discretely placed anywhere inside or outside the home. Our weather-resistant mechanical design has withstood adverse weather conditions in many countries around the world. We have won multiple awards for our outstanding product design including Red Dot design awards and CES Innovation awards.

 

    Broad Compatibility. We have purposefully designed Arlo products to be integrated with leading third-party IoT products and protocols, such as Amazon Alexa, Apple HomeKit, Apple TV, Google Assistant, IFTTT, Stringify and Samsung SmartThings. This broad compatibility enables features such as accessing Arlo through smart assistants using voice commands and integrating with other smart home products.

 

   

Cloud-Based Platform. Arlo’s cloud-based platform allows for seamless integration of our best-in-class devices and Arlo Smart services. The Arlo cloud infrastructure securely stores millions of hours of user content while providing users instant access to their video library. For March 2018, Arlo users collectively streamed an average of over 60 million videos daily. Our platform links our

 

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users’ smart connected devices to our powerful, easy-to-use app, which provides users access to and control of their connected Arlo ecosystem. Our scaled cloud infrastructure is optimized to accommodate our growing user base and provide actionable intelligence in real time using our proprietary, AI-based algorithms.

 

   

Artificial Intelligence. We use neural networks and machine learning to continually improve the performance of our detection and computer vision algorithms. Our algorithms are trained using thousands of hours of high-quality, user-donated content. This continual training and refinement allows us to develop what we believe to be superior AI-enabled features, such as person detection capabilities tested with a 90% accuracy rate. Our smart, real-time notification engine uses our accurate computer vision capabilities to distinguish between a person approaching the door and other types of movement, such as trees swaying in the wind, and will trigger notifications appropriately for users. As we refine these intelligent features, we expect to continue to enhance the end-user experience.

Market Leadership in Consumer Network Connected Cameras. Since the launch of our first product in 2014, Arlo has shipped over 7.5 million smart connected devices and, as of April 1, 2018, has over 1.9 million registered users across more than 100 countries around the world. Our leadership in the consumer network connected camera systems market is an integral part of our vision to be a leading connected lifestyle platform. According to NPD, for the second quarter of 2018, we held 48% market share based on dollar sales in the U.S. consumer network connected camera systems market.(11) Outside of the United States, we are also the leader in Australia and several major European markets. We believe Arlo’s scale and market leadership in consumer network connected camera systems positions us well to gain further market share in the broader connected lifestyle market.

Direct Relationship with Users and User Engagement. Our fully integrated hardware, software and services platform provides an intuitive and engaging user experience, which distinguishes our product offerings and contributes to our rapid growth. According to Sensor Tower, for the first quarter of 2018, the Arlo app had a user engagement rate, measured by daily active users divided by monthly active users, of 37%. Sensor Tower’s data also shows that, during the same period, the Arlo app’s number of daily active users was in line with the median of the 500 most downloaded apps from the Apple App Store and that the Arlo app had a user engagement rate in the top 6% of these apps. While not one of these 500 apps, the Arlo app’s user engagement rate compares favorably to many of the most engaging social media and entertainment apps available. Unlike legacy consumer devices, we maintain an ongoing relationship with the end-user of our products through the Arlo app. We believe that a high engagement rate will continually improve end-user loyalty, lead to a better overall user experience and increase our revenue from paid subscription services. Furthermore, the online Arlo Community, accessed through our website, serves to reinforce brand loyalty and support. The Arlo Community gives our team feedback and suggestions for future products and features through our website, enabli