Wireless home security camera specialist Arlo Technologies (ARLO 5.26%) had a solid third quarter, with revenue climbing 25% and registered users of its cloud-based monitoring platform surging 88% from last year. Paid subscribers doubled, but because management also warned gross margins would contract in the fourth quarter while revenue would grow a maximum of 20%, Arlo's stock tumbled in the aftermath.
There are some troubling trends. Across all important metrics, including revenue, registered users, and paid subscribers, growth rates are slowing. Arlo says it will need to spend heavily to attract new customers, which bears watching because it may mean it can't grow without regularly sacrificing profits to expand its user base.
Image source: Arlo Technologies.
Changing horses midstream
Arlo Technologies is in the midst of a transition from hardware maker to software company, a reasonable strategy as the latter doesn't have to rely on a continuous upgrade cycle to see regular growth. Steady, recurring streams of revenue from subscription renewals tends to carry much better profit margins than needing to continuously invest in new equipment.
Yet making the leap isn't always easy nor is success guaranteed. Fitbit (NYSE: FIT) finds itself in a similar bid to migrate from relying upon making fitness bands and smartwatches to generating revenue from its health coaching platform. But as my fool.com colleague Evan Niu recently highlighted, Fitbit is making little progress and may be seeing the number of users decline. Action camera maker GoPro (NASDAQ: GPRO) also hasn't had it easy in reducing its reliance on the hardware side of its business by enhancing its GoPro Plus subscription service.
And though businesses do need to spend money to attract new customers, if they can only expand membership rolls by investing large sums of cash, that can be a prescription for disaster. Just ask meal-kit delivery specialist Blue Apron (NYSE: APRN), which experiences large increases in delivery subscriptions when its marketing budget swells, but as soon as it lets its foot off the gas even a little, the numbers tumble.
Arlo may be finding itself in the midst of both of these extremes. Like GoPro and its Hero series of cameras, Arlo's security cameras are so well made that customers can go for long periods of time without needing to upgrade. And while the market for them is expanding, it's also finding increased competition from Amazon.com (NASDAQ: AMZN) and Alphabet's Google, which are coming out with lower-priced equipment.
Data source: Arlo Technologies. Chart by author.
Promotional in a competitive environment
The security camera specialist says the fourth quarter is going to be much more promotional because of the holidays. And since the Christmas selling season has expanded, it began its marketing push last month and will carry it through December. More importantly, it will maintain its promotional campaign well into 2019, with CFO Christine Gorjanc saying it will span the first six months of the year.
Home security may be a different, better opportunity for capturing recurring revenue streams than health monitoring, action cameras, or meal kits because of the emotional desire to keep tabs on the safety and security of your home and the people who live there, but Arlo is under increasing competitive pressure.
For example, through its purchase of smart doorbell company Ring, Amazon is expanding both the types of products it's offering and the services for them. In addition to cameras, it sells a whole house security system for less than $200, with 24/7 professional monitoring and no contracts or cancellation fees for just $10 per month for an unlimited number of cameras.
Arlo offers basic video storage service for free, which is included with its cameras, and offers smartphone notifications beginning at $10 per month, but only for 10 cameras. Its higher-cost Elite plan would allow for up to 20 cameras.
Key takeaway
Arlo Technologies is still growing its brand and the money it makes from it, but growth rates are already slowing, and with significant competition vying for a larger piece of the market, there may be even more difficult periods ahead. It may be tough for Arlo's stock to regain the highs it briefly held right after its IPO.
