Prepared remarks
Ladies and gentlemen, thank you for standing by. I would now like to turn the conference over to Tahmin Clarke. Please go ahead.
Before we begin the formal remarks, we advise you that today's conference call contains forward-looking statements. Forward-looking statements include statements regarding our potential future business, operating results and financial condition, including our description of revenue, gross margins, operating margins, earnings per share, expenses, cash outlook, free cash flow and free cash flow margin, ARR and other KPIs, guidance for the third quarter and full year 2026, the long-range plan targets, the rate and timing of paid subscriber growth, the commercial launch and momentum of new products and services, the timing and impact of tariffs, strategic objectives and initiatives, market expansion and future growth, partnerships with various market leaders and strategic collaborators, continued new product and service differentiation and the impact of general macroeconomic conditions on our business, operating results and financial condition. Actual results or trends could differ materially from those contemplated by these forward-looking statements. For more information, please refer to the risk factors discussed in Arlo's periodic filings with the SEC, including our quarterly report on Form 10-Q filed earlier today. Any forward-looking statements that we make on this call are based on assumptions as of today, and Arlo undertakes no obligation to update these statements as a result of new information or future events. In addition, several non-GAAP financial measures will be discussed on this call. A reconciliation of the GAAP to non-GAAP measures can be found in today's press release on our Investor Relations website. At this time, I would now like to turn the call over to Matt.
Thank you, Tahmin, and thank you, everyone, for joining us today on Arlo's Second Quarter 2026 Earnings Call. Arlo delivered outstanding results in Q2 with service revenue, total revenue, gross profit and non-GAAP net income, all setting new records for the company. We saw strength across the business and across all channels, which, in addition to the team's great execution, generated the excellent outcome you see today. Point-of-sale units in our retail and direct channel were up 8%, which contributed to the nearly 300,000 paid account additions in the quarter. This brings our total paid accounts to 6.3 million, which is substantially ahead of the original trajectory to our long-range target of 10 million. The quality of our paid accounts portfolio continues to increase when compared to the same period last year. Our average revenue per user is up, churn is down and both monthly and annual subscription renewals came in higher than our forecast. These continuous improvements are due to several internal projects and programs that utilize deep user insights, which are focused on delivering the best user experience in the world. The result is Arlo's lifetime value of a paid account has risen to $967, which is up 15% compared to a year ago. Total revenue grew to $156 million, up more than 20% year-over-year and setting a new record for the company. Service revenue of $93 million, also a new record, grew 19% year-over-year and comprised 60% of our total revenue in the quarter. This top line performance drove an incredible 70% year-over-year growth in adjusted EBITDA, which reached $31 million in Q2. And when combined with a partial tariff refund, propelled non-GAAP earnings to $0.28 per share, up 65% when compared to a year ago. As in past years, we use this mid-year checkpoint to assess the market conditions and our performance over the first half as we finalize plans for the second half and begin the development of our annual operating plan for 2027. Our focus is to utilize Arlo's resources to deliver growth in both the short term and long term to drive the expansion of shareholder value. The capital allocation strategy that we rolled out nearly two years ago has served as an excellent framework to drive that growth in value. Our investments across the pillars of organic, inorganic and shareholder return are delivering the desired outcomes, and I would like to spend a moment to update our investors. Our organic or internal investments fall into three main buckets: operational excellence, sales and marketing and platform innovation. Operationally, Arlo is deploying new tools and processes that when coupled with our vast user data are unlocking value and providing detailed insights that we are leveraging to improve the key metrics I mentioned earlier. We are still at an early phase and we'll continue to invest where we see the potential for high ROI or improvement in Arlo's key metrics. From a sales and marketing perspective, you will see us balance both short-term and long-term growth. As in past years, we intend to invest in our retail channels during the holiday selling period to drive incremental growth in subscribers now worth nearly $1,000 each in LTV. And you'll see us also invest in some market tests for both care and small business segments to collect data that will help feed our 2027 business plan and other future opportunities for growth. It is exciting to see Arlo on the cusp of entering these large markets that can generate substantially higher ARPU and LTV. Finally, our internal innovation pipeline has never been stronger. Arlo will launch Arlo Secure 7 at the end of Q3 with several new features and capabilities that keep us at the forefront of smart security and open the door to additional service plan options at higher price points. And looking into 2027, Arlo will be launching a next-generation product line, coupled with Arlo Secure 8 that together will represent the most innovative and impactful advancement to customer experience in home security since Arlo's initial launch of DIY security more than 10 years ago. Looking at the inorganic area of our capital allocation plan, Arlo generated a greater than 50% return from our Origin AI investment. And the acquisition of Aloe Care has enabled Arlo to address the $30-plus billion market for smart elder care and aging in place. Based on the early progress since the acquisition closed, we expect to have several additional partner announcements that will contribute to growth in 2027. We remain bullish but selective on future inorganic investment opportunities and continue to look for either smaller adjacent assets or potentially larger options if they fit directly into our core market. From a return to shareholder perspective, Arlo has bought back nearly 6 million shares since the inception of our share repurchase program and more than $20 million of shares in Q2 alone. The board and the management team continue to believe that Arlo's shares are substantially undervalued, and you should expect to see additional share repurchases going forward. Taking this all together, Arlo had a record-breaking Q2, strong first half and is executing a capital allocation plan that is contributing to short-term growth while positioning the company for additional growth in 2027 and beyond. I have never been more excited about Arlo's potential and believe that the next 18 to 24 months will begin a new phase of success for the company. And now I'll turn it over to Kurt for a more detailed review of our Q2 results and our outlook for the remainder of 2026.
Thank you, Matt, and thank you, everyone, for joining us today. First, I will provide a detailed review of the key operational and financial results of the business. Then I will share an overview of our expectations for the third quarter, followed by an updated outlook for full year 2026. We continue to deliver outstanding top and bottom line growth, driven by a quarter of record subscriptions and services revenue, coupled with record total revenue. Arlo continues to outperform expectations as a result of our subscriptions and services focus, which drives our expanding profitability metrics, including record levels of non-GAAP gross margins, adjusted EBITDA and non-GAAP net income. And we are well positioned to continue these trends into the back half of 2026. During the period, we posted subscriptions and services revenue of $93 million, up 19% year-over-year and once again accounting for 60% of total revenues. Our subscriber base grew 23% year-over-year as we generated 298,000 new paid accounts in the period. This double-digit subscriber growth was bolstered by our outstanding customer retention efforts, especially the results generated in our retail business. Our subscriber growth, coupled with a slight increase in ARPU, drove ARR to $365 million, up 16% year-over-year. Product revenue was $62.9 million, up 23% from $51.2 million in the same period last year, a trend driven by strong growth in international business as well as strong device shipments into retail channels in advance of Amazon Prime Day, which began in late Q2 of this year. Both of these factors resulted in additional retail sales with POS or point-of-sale volume increasing 9% for the first half of 2026 in comparison to the same period last year. Our strategy to optimize our promotional campaigns around retail channels and product offerings that have higher subscription conversion rates helped enhance growth of our high-margin domestic retail subscription offerings. Total revenue for the period came in at $155.9 million, a record and up 21% from the prior year, driven by the strong double-digit year-over-year growth in both subscriptions and services revenue as well as higher product revenue. Generating total revenue at this level is a testament not only to the strength of our services revenue trajectory, but also to the diversification of our go-to-market strategy. From this point on, my discussion will focus on non-GAAP numbers. The reconciliation from GAAP to non-GAAP figures is detailed in our earnings release, which was distributed earlier today. In line with our guidance, non-GAAP subscriptions and services gross margin was 84.1%, which was slightly impacted by non-recurring engineering services revenue, or NRE associated with the ramp of our strategic partners. We reported non-GAAP product gross margins of 1%, up significantly from the negative 13.8% in the prior year period, primarily related to the $8 million in tariff refunds that were recorded during the period as well as a higher mix of product sales coming from our strategic partners. On a pro forma basis, after adjusting for tariff refunds in the quarter, our product gross margins would have been a negative 11.6%, which still represents an improvement of 220 basis points year-over-year. With the improvement in both services and product gross margin, we again surpassed the 50% consolidated non-GAAP gross margin level, an increase of 480 basis points year-over-year. Consolidated gross margins at this level represents a new record and underscores the continuing uplift in profitability we are experiencing. Total non-GAAP operating expenses for the second quarter were $48.6 million, up 16.5% from $41.7 million in the same period last year. The year-over-year increase is driven by investments in R&D, including headcount to continue to drive our technology innovation ahead of our Arlo Secure 7 launch. Additionally, as mentioned earlier in the year, we are investing in delivering platform advancements for our strategic partners ahead of their launch of services. Lastly, we experienced an increase in fees associated with professional services to support our growth initiatives and deliver an enhanced customer experience. During the quarter, adjusted EBITDA was $30.6 million, up 70% year-over-year and representing an adjusted EBITDA margin of 20%. Even in an investment year, which requires additional spend to integrate large-scale strategic partners into our platform, we are still expanding our adjusted EBITDA and margins, a testament to the significant operational and financial progress Arlo has made in its transformation. Profitability at this level translates into non-GAAP net income per diluted share of $0.28, including a favorable $0.07 impact due to tariff refunds. On a pro forma basis, assuming the exclusion of tariff refunds, our non-GAAP net income per diluted share would have been $0.21, ahead of both the midpoint of our guidance range and consensus EPS estimates in the quarter. Regarding our balance sheet and liquidity position, we ended the quarter with $141 million in available cash, cash equivalents and short-term investments. This balance includes investments in various capital allocation initiatives, including $22 million as part of our stock repurchase program and $15 million as the cash paid in the period to acquire Aloe Care. For the 6 months ended June 28, 2026, we generated $33.9 million in free cash flow or a free cash flow margin of 11%. Our Q2 accounts receivable balance was $63.6 million at quarter end, with DSOs at 37 days, down from 43 days last year as we continue to drive more subscribers to annual service offerings. Our Q2 inventory balance was $48.4 million, up from the $30.9 million level last year. Inventory turns, excluding acquired inventory, were 5.5x, a decline from 7.7x last year as we look to optimize our inventory levels in an effort to reduce our shipping costs and manage any potential future increase in memory costs. Now turning to our outlook. We had an outstanding start to the year, driven by ongoing strength in our subscriptions and services business, which drove both our revenue and profitability. Looking forward, we expect the momentum in our subscriptions and services business to continue into the second half of 2026, and we expect total revenue in the third quarter to be in the range of $140 million to $150 million. From a profitability perspective, we will leverage any Q3 tariff refund to further invest in the strategic areas that are fueling our growth. This includes strategic partners such as Comcast and ADT, second half promotional campaigns with our top channel partners, innovation across our technology platform and market tests ahead of our 2027 annual operating plan. Despite these incremental investments, we expect our non-GAAP net income per diluted share in the third quarter to be substantially ahead of consensus and in the range of $0.17 to $0.23. As a result of our strong first half and our outlook for the remainder of 2026, we are significantly increasing our outlook for total revenue and EPS for the full year. We are now expecting total revenue for the year to be in the range of $580 million to $600 million and non-GAAP net income per diluted share to be in the range of $0.90 to $1. And now I'll open it up for questions.
Questions and answers
Your first question comes from the line of Jacob Stephan from Lake Street Capital Markets. Please go ahead.
Congrats on a really nice quarter here. Maybe just first, kind of looking at the full year guide raise. I guess when you kind of think about ARR growth for the full year, where does that land? And how comfortable are you with those targets?
Thanks for the question, Jacob. As you saw, we had some really strong growth on the service revenue side, just touching about almost 20%. If you look at the metrics we talked about on the call, churn improving, conversion improving, ARPU actually raising up a little bit, that is driving that LTV almost to $1,000. That's usually a leading indicator of further growth when you look out on ARR as you go through the year. I would couple that with the Arlo Secure 7 launch that's going to be happening sometime in September. That is not only going to bring a lot of new functionality to the table, it's enabling us to bring a higher tier of service. So you'll see us actually add a subscription tier that's higher priced than the two that we have in the field today. That will obviously serve to grow ARR as we exit the year. Typically, you see some strength and growth in ARR as we get towards the end of the year because of our launch of our products. But I think the metric improvement is usually a leading indicator as well. So we are targeting toward that 20%, not only on service revenue, which we're basically at now, but also on ARR as we exit the year.
Got it. Maybe just on Secure 7, since you talked about it, you highlighted the Q3 launch. What features are going to be incremental about Secure 7 that aren't already in Secure 6? And how do you think about the market appetite for higher ARPU offerings at this point?
I don't want to get ahead of our launch in too much, but there are some functionalities and features we've talked about in the past that I can touch on to give you more color. First, we've talked about the idea of the next level of AI enhancement or AI capabilities in the consumer security space. Most AI is usually object detection or inferring from facial recognition where you're detecting an object and notifying or taking action. What we've been working on for more than a year now goes to the next level: actually assessing the entire event and the threat level driven by that event. That assessment of what's happening is another level of what AI can do and provides numerous improvements to both user experience and the speed of emergency response in events that require that, while also filtering out false alarms. This functionality will be a dramatic improvement to the customer experience and can be leveraged with our strategic partners to have better outcomes, both on response speed and reducing false detection. You're also going to see numerous customer enhancements that have been requested over the last 1.5 years; we typically roll up requested functionality into user improvements at the app and service levels. There is also a class of users who pay separately for continuous video recording (CVR). You'll see a new tier of service and a lot of enhancements and innovation in that area that we think will unlock the benefits of a higher tier service. There's a lot in there; we'll provide a lot more detail when it launches in September.
Got it. Maybe last one for me. The last few quarters, we talked a lot about strategic partnerships, 3 notable ones, ADT, Samsung and Comcast. ADT Blue is launched, but how are things with Comcast Xfinity? Where are you in the testing phase with them? Any update would be helpful.
Everything is progressing extremely well. ADT has now launched, and as we said before launch, we expect them to ramp through this year, especially in the back half with the holiday quarter, and then lean in even more for a full year next year. That's exactly what we're seeing. We're expecting significant marketing spend and visibility from ADT for their Blue offering. With Comcast, the integration and development are exactly on track. We spent time with them in Philadelphia recently, and there's probably more opportunity with this partnership across even more fronts of services they want to deploy over time. We're heads down; everything is on track. If anything, there's a desire to try to get this launched closer to Q1 than Q2 next year, but a lot will depend on test units in the field. I'll have more to say about Comcast in the first half of next year.
Very helpful. Nice quarter. Thank you very much.
Your next question comes from the line of Dylan Becker from William Blair. Please go ahead.
I wanted to touch quickly on the ARPU uplift and reduced churn leading to higher LTV, and obviously seeing pretty healthy product strength across the portfolio. Part of that was channel-led. To what extent is that starting to be some of those strategic partnerships ramping, and how does that drive conviction as you get more devices installed within each home to drive uplift in conversion through better homes as part of that product motion?
You hit on all three components. We saw strength in the partner channel; it was strong and fairly typical for seasonality, but definitely strong. Kurt mentioned strength in our retail and direct channel as well. Some of that pull was the early shipments for Amazon Prime Day, which shifted a few weeks into Q2. In general, we're capturing share and seeing strength in both retail and partnership channels. Those new devices often end up in new households, which increases future ARR and service revenue. Even within existing households, when a household moves from one camera to two or from two to three, the conversion or attach rate to service revenue goes up. So when unit volume rises year-over-year, that indicates future service revenue and ARR growth.
Appreciate it. On the tariff savings being utilized to reinvest more aggressively into the partnership motion, can you give additional context on what that looks like? I know some of these will ramp in the back half and into 2027, but what incremental investment or spend can further unlock or accelerate that motion?
We had about $8 million in a tariff refund in Q2, roughly $0.07 of EPS. For Q3, we expect roughly $6 million, about $0.05 EPS. Given the high ROI opportunities, we decided to use the Q3 found gross profit for strategic investments. At an executive offsite, we discussed uses: sales and promotional investments for Q3 and Q4, accelerating partner integrations and platform work for Arlo Secure 8 and next-generation technology, and small market tests for Aloe Care and small business in Q3 and Q4. These tests are relatively small but will provide data to build a disciplined 2027 plan. In Q2, because the tariff refund timing was uncertain, we dropped it to the bottom line. For Q3, with more predictability, we're using a smaller rebate to fund strategic growth and exploration that should yield short-term and near-term (18-month) returns for shareholders.
Your next question comes from the line of Rian Bisson from Craig-Hallum. Please go ahead.
Quickly on the Aloe Care, the Home Helpers deployment seems like the first commercial expansion since you closed the acquisition. How does that channel work, what's the reception from care providers, and how are you thinking about Aloe Care runway into next year?
We acquired Aloe Care for its technology and its pipeline. Home Helpers is a provider that offers on-site support for elderly care and uses Aloe Care to monitor health and communicate with people in the field, enabling scaling. We will roll out Aloe Care’s new technologies, including AI calling and AI check-ins, which are impressive and allow scaled check-ins and dashboards for caregivers. The AI can correlate user feedback and help predict issues like falls or dehydration from conversations. Home Helpers is an initial partner example; expect several more partner announcements over the next 6 to 9 months. These will contribute some growth this year and set up substantial growth in this segment in 2027.
Your next question comes from the line of Scott Searle from ROTH Capital Partners. Please go ahead.
Congrats on the quarter. We used to talk a little about unpaid subscribers and monetizing them via advertising trials to drive upsell. Any update on monetization of the unpaid subscriber base?
We've seen strong success advertising to non-paid subscribers. We tested selling hardware, services, and third-party advertising in that free-with-ads bucket. The ROI was highest when advertising converted users to paid subscriptions. We've converted tens of thousands of subscribers from unpaid to paid this year through advertising. We'll continue to lean into this and plan to advertise Aloe Care services and other opportunities to increase subscription conversion. Historically, we've also promoted second-camera offers to single-camera households, which drives healthy conversion. We'll experiment more with these approaches late this year and into the first half of next year ahead of Arlo Secure 8.
Regarding Aloe Care, are you starting to develop incremental channel partners and deploy those services? How does the DIY self-install model fit for Aloe Care — might we see more of that in 2027?
That's one of our Q4 tests. Aloe Care, prior to acquisition, focused on certain providers and government channels. After acquisition, we had substantial inbound interest from retail channels, state and federal agencies, healthcare providers, and some of our strategic partners. We're evaluating the opportunity stack and deciding where to allocate resources; that's part of the Q3 investments. One specific market test will deploy Aloe Care into the direct-to-consumer DIY channel to gather data for our 2027 operating plan.
How active are explorations of other adjacencies and how do you weigh that relative to capital allocation and buybacks? Also, Kurt, just to clarify: the tariffs in Q2 were a contra to COGS producing the 1% gross margin. Going forward, should we model product gross margin around that negative 10% range?
Yes. For Q2, the $8 million tariff refund was applied to product gross margin, giving the 1% positive margin. Looking out, our strategy remains to use product gross margin as a customer acquisition tool. You should expect margins on the product side to revert to negative mid- to high-single digits, maybe even up to the teens, as we deploy promotions to drive household activation. We'll manage product sales and margins to target POS growth around 9% to 10%.
There are many adjacencies we could pursue, but we need to be selective. Aloe Care represents a large TAM, and we want to execute well and demonstrate ROI quickly. We have small business tests planned and are focused first on making Aloe Care successful. We may consider inorganic opportunities that fit our core market and could accelerate growth; we're watching consolidation in the space and could be a benefactor of that.
Your next question comes from the line of James Fish from Piper Sandler. Please go ahead.
Any further color you can give around the impact of Prime Day shifting from Q3 to Q2 this quarter?
This was the first year that Prime Day moved from Q3 into Q2, which pulled some product revenue into the quarter and increased shipments associated with the event. Our product revenue growth was a combination of international business and retail partners, particularly the Prime Day event. We performed well relative to our forecast and are pleased with the outcome. We expect product revenue to remain healthy in Q3 despite the timing shift.
To add, the shift is not massive because even when Prime Day is typically in July, some shipments occur in Q2 to prepare. So only a couple of weeks of shipments shifted into Q2; it's not the full volume that would otherwise be in Q3.
Any way to think about the net add pace for paid accounts and what you expect from new conversions for the rest of the year?
Our net paid accounts are progressing very well and are above the range we previously discussed. We're overachieving on that metric. The mix of sales matters: how many are net new households versus additional devices in existing households. We've been analyzing which offers and SKUs drive new household formation versus additional purchases by existing households. In the second half of the year, we'll shift promotional dollars to SKUs and channels that drive household formation, which should accelerate net adds. We expect conversion to tick up through the holiday period as we deploy smarter promotional capital.
Finally, what traction are you seeing with more premium subscription offerings? How much of the upside this quarter was driven by premium offerings versus new household adds?
ARR increase this year has been driven largely by mix shift into higher-tier plans. We saw higher growth in sales of higher-end products like Arlo Pro and Arlo Ultra this quarter, which tend to lead customers to subscribe to higher-tier plans. We expect that mix shift to continue, particularly with the higher-tier plan that will be part of Arlo Secure 7.
Your next question comes from the line of Adam Tindle from Raymond James. Please go ahead.
On the gross margin, Kurt, the pro forma core product gross margin excluding tariff was roughly negative 11%. What drove that down sequentially after progress in Q1? Is that seasonal or related to ADT Blue dilution? And what are your expectations for product gross margins for the rest of the year?
That negative margin reflects the natural seasonal cadence of promotions and product shipments. Prime Day being pulled into Q2 required setting up promotional campaigns and inventory, which impacted product gross margin. The $8 million tariff refund was somewhat unexpected in timing and offset that margin in Q2. Pro forma, the negative 11% was in line with our expectations given the Amazon event. Looking ahead, we expect product margins in the mid- to high-single-digit negatives, possibly up to the teens, given how we manage promotions to drive POS growth, which we've targeted around 9% to 10%. We're managing product gross margins consistent with our strategy to use product as a customer acquisition tool.
Follow-up for Matt: you raised full-year revenue guidance, predominantly product. Given product is loss-making on a gross margin basis, why accelerate revenue at that margin? Also, why didn't you increase service revenue guidance if product is expected to drive future subscriptions?
Accelerating product revenue is often a precursor to subscription revenue because those devices go into new households and then convert down the funnel to subscriptions. We didn't update service revenue guidance because it's already at about 20% growth and we believe it's achievable; there's upside potential. The metrics—higher LTV, improved conversion, better renewals, lower churn—support the idea that accelerated product sales will drive subscription growth over time. So we are willing to invest in product and promotional activity now to drive higher-margin recurring revenue later.
Your final question comes from the line of Martin Yang from Oppenheimer. Please go ahead.
Follow-up on consolidation commentary: what opportunities for consolidation do you see in the market?
We see consolidation mainly in the retail space where retailers may reduce the number of brands on shelf and double down on brands delivering for them. When that happens, we've tended to gain shelf share and market share. From an inorganic perspective, there could be opportunities to acquire assets with households but without success in converting those into subscriptions. If there are companies with cameras in households where Arlo's ability to convert to subscriptions could add value, that could be an acquisition opportunity. So the consolidation we see is both shelving consolidation in retail and potential acquisitions of companies that have households or assets where we can apply our subscription conversion expertise.
Another question on subscription tiers: can you give more insight on current tier composition and how Arlo Secure 7 or next year's hardware might change composition across tiers?
Historically, Arlo had three tiers: basic, a tier with AI capabilities, and a full-featured tier with professional monitoring, battery backup, and cellular backup. About 1.5 years ago we saw many customers move up to the AI-enabled tier, so we removed the basic tier. Today we effectively have two tiers: one with most AI functionality and a higher tier with additional features including professional monitoring and backups. Optimally, three tiers (good, better, best) are ideal, and in September we'll be introducing a tier above our current highest tier. Over time, the distribution of customers across tiers will shift, and you'll see that reflected in ARPU expansion.
At this time, there are no further questions. This concludes today's call. Thank you all for attending. You may now disconnect.