Arlo Technologies, Inc.
Q3 2018 Earnings Call Transcript

Published: 27 Oct 2018

[Operator:]

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

[Erik Bylin:]

Thank you, Operator. Good afternoon and welcome to Arlo Technologies third quarter 2018 financial results conference call. Joining us from the company are Mr. Matt McRae, CEO; and Ms. Christine Gorjanc, CFO. The format of the call will start with an introductory commentary on the business provided by Matt, followed by a review of the financials for the third quarter and fourth quarter guidance provided by Christine. We will then have time for questions. If you have not received a copy of today’s press release, please visit Arlo's Investor Relations website at www.arlo.com. Before we begin the formal remarks, we advice you that today's conference call contains forward-looking statements. Forward-looking statements include statements regarding expected revenue, gross margins, operating margins, tax rates, expenses, and future business outlook. Actual results or trends could differ materially from these contemplated by these forward-looking statements. For more information please refer to the Risk Factors discussed in Arlo's periodic filings with the SEC including the most recent Form 10-Q. Any forward-looking statements that we make on this call are based on assumptions as of today and Arlo undertakes no obligation to update these statements as a result of new information or future events. In addition several non-GAAP financial measures will be mentioned on the call today. A reconciliation of the non-GAAP to 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.

[Matt McRae:]

Thanks, Eric, and thank you everyone for joining us on Arlo's first earnings call. We are thrilled to be here with you as a newly public company. We had an outstanding quarter, delivering a record $131 million in revenue which represents 25% year-over-year growth. Arlo Pro 2 which is the latest generation of our battery operated weather resistant Wi-Fi cameras continue to be the flagship product during the quarter complemented by the strong performance across our other camera and non-camera product categories. We also added approximately 300,000 registered users to the Arlo platform during Q3 which represents 88% year-over-year growth. Our paid subscriber base grew at an even faster rate of 105% year-over-year growth reaching approximately 125,000 subscribers at the end of Q3, with nearly 23,000 subscribers being added during the third quarter which is also a record for Arlo. We are pleased with the progress that we are seeing with the rollout of Arlo Smart, our AI driven subscription service that enhances the experience of Arlo customers. At launch, Arlo Smart provided customers with person recognition, cloud activity zones, rich notifications, enhanced 911, and additional video storage. This morning, we announced an updated Arlo Smart service which adds innovative features such as vehicle detection, package detection, animal detection, as well as smoke alarm, and Co2 alarm detection. With smoke and Co2 alarm detection, we have added audio AI and machine learning to our Arlo Smart platform. Our intention is to continue increasing the value of our subscription services over time and we believe that every new release of Arlo Smart fuels additional acceleration of paid subscribers. Based on the positive user feedback, and adoption of Arlo Smart, we have made the decision to sharpen our focus on registered user growth. As such, we are setting a new target for the company to add an additional 400,000 registered users during Q4. Our strategy of aggressively growing our registered user base continues to lay the foundation to grow our number of paid subscribers. Given that the Arlo story is likely new to many of you, I would like to take a step back and provide some background on the company. Arlo originated from an acquisition that NETGEAR made in 2012 which provided the technology for delivering video via a battery powered camera. This laid the foundation for the wire-free cameras that Arlo has become known for today. Arlo was the first to deliver a truly wire-free camera for security, monitoring, or other used cases to the consumer IoT and security industry. When we say wire-free, we mean that the camera is a 100% wireless from both a data perspective as well as a power perspective. Being wire-free made installations so much easier that revolutionized the way that consumers buy security and monitoring. With Arlo's innovative approach anyone could walk into a BestBuy, Costco, or go online to Amazon buy security cameras at an affordable price and have them fed up in a matter of minutes. This was simply not possible before Arlo. Over the last few years, we have continued to innovate on that foundation by releasing higher performance cameras such as Pro 2, last week was named best home security camera by Digital Trends and tailored variations such as Arlo Baby and the LTE connected Arlo Go. The typical Arlo customer is a multicamera household that wants coverage around their entire property not just at the front door or above the garage. By combining our market leading battery life in a range with a broad suite of products and services, we are uniquely positioned to deliver the solution. We've also been building a robust cloud platform that is specifically tuned for IoT used cases. It is low latency and has artificial intelligence, computer vision, two-way audio, and cloud storage integrated to provide a high performance and scalable architecture for a broad set of products and services. Using this platform, we launched Arlo Light and the new Arlo Doorbell which have the ability to pair with and cross trigger our cameras. The Arlo Doorbell has the unique ability to think live audio and video from two separate hardware devices allowing our customers the flexibility to independently locate the camera and doorbell. This provides the best coverage for monitoring and security no matter the design allowed of a users entry way. The doorbell also utilizes our new high performance audio platform which provides a fast, phone-like communication experience that is differentiated from the other solutions on the market. Towards the end of the quarter, we are planning to leverage our deep retail channel partnerships to further accelerate subscriptions to Arlo Smart. We plan to rollout a new business model with a core product that replaces the current basic service plan with a bundled one-year subscription to Arlo Smart. We believe the combination of our IoT platform, our industry-leading devices, and a high customer satisfaction we are seeing with Arlo Smart will drive a healthy subscription renewal rate and a competitive advantage that will fuel Arlo's success in the long run. The addressable market that we're going after is massive and unpenetrated. According to Gartner, the addressable market for connected home devices will grow at a 34% compound annual growth rate over the next three years to reach a $146 billion in 2021. We're seeing the IT camera market continue to grow as many households worldwide have yet to purchase their first security solution for the home. According to the NPD Group for the third quarter of 2018, we held 41% market share based on dollar sales in the U.S. consumer network connected camera systems market. We are also seeing categories like light and doorbells growing rapidly both of which we have only now just entered. Looking forward, we are focused on the following growth drivers. First, we have increased our R&D expenditure to ensure we continue to innovate and expand our product and service offerings. This will allow us to execute our strategy to aggressively acquire new registered users which will be critical to accelerating our paid subscriber growth. We will be announcing a new product category at CES and executing an extensive product and service introduction cycle starting at the traditional retail recess and continuing through 2019. Second, we are actively exploring incremental channel opportunities for 2019, including SMB, government, service provider, insurance, and home builders. With our technology, our installed base, our increased focus as a separate company, and the world class team that we have at Arlo, we see enormous opportunity to continue our strong growth in the years ahead. I'd like to now turn the call over to Christine for her commentary on the third quarter and guidance for the fourth quarter.

[Christine Gorjanc:]

Thank you, Matt. It's great to be here on Arlo's first earnings call. As Matt highlighted, we had an excellent quarter delivering a $131.2 million of revenue which represents an increase of 25.1% year-over-year. Our services revenue for the quarter was $9.8 million, which is up 25.9% year-over-year. During the third quarter, we shipped a total of 1.2 million cameras and 1.4 million devices. As Matt just shared, we added approximately 300,000 registered users to the Arlo platform in Q3. As of the end of the third quarter, we had about 2.5 million registered users which is 88% more than we had a year ago. We continue to believe that growing our registered user base is critical to growing our recurring subscription business. Our paid subscriber count for Q3 was approximately 125,000 which is up a 105% year-over-year. We're pleased with the growth in our subscriber base and believe today's Arlo Smart release with new functionality will continue to expand the subscriber base. From this point on my discussion points will focus on non-GAAP numbers. The reconciliation from GAAP to non-GAAP is detailed in our earnings release distributed earlier today. Our non-GAAP gross profit for the third quarter of 2018 was $30.4 million which resulted in a non-GAAP gross margin of 23.1%. This compares to $28.9 million in the year ago comparable period and $29 million in the prior quarter. Please note that the historic comparison to period's reference carve-out financials whereas our Q3 results are based on standalone financials. Further detail regarding carve-out financials is contained in our SEC filings including our previously filed form S1 and related public offering perspectives. Our standalone financials represent our actual results for the period as a standalone public company. Total non-GAAP operating expenses came in at $34.1 million, which is up 61.9% year-over-year and up 12.9% sequentially. Our headcount at the end of Q3 2018 was approximately 344 employees. We are strategically investing in the areas which we believe are key to the growth of our business in addition to adding resources to fully separate from NETGEAR. Our non-GAAP R&D expense for the third quarter was 11.6% of revenues unchanged from 11.6% of revenue in the prior quarter. R&D is critical to our product and service differentiation and we continue to invest heavily in R&D for Arlo as we execute our hardware and services roadmaps and continue to expand revenue. Our non-GAAP tax expense for the third quarter of 2018 is $223,000 and for the third quarter of 2018 we posted a non-GAAP earnings per share loss of $0.05. We ended the quarter with a $187.8 million in cash and cash equivalents and short-term investments. We received approximately $173.4 million in net proceeds from the IPO after deducting IPO-related fees paid by Arlo, a portion of the IPO-related fees was paid by NETGEAR and approximately $70 million from NETGEAR during Q3. We plan to use the proceeds from the IPO to increase our investment in R&D and marketing to continue to drive differentiated features for our products and subscription services. Looking out to 2019 we plan to rollout a comprehensive lineup of products and feature additions, starting with the spring reset. Turning to tariffs, the majority of our products are not manufactured in China. A select few of our older product lines are currently manufactured in China and we are winding that down. We respect to complete this by the end of Q1 2019. We anticipate that wrapping up our China manufacturing will result in a one-time charge of approximately $4 million over the next two quarters with the majority of this charge impacting the Q1 2019 gross margin. Turning to guidance for the fourth quarter of 2018, we continue to believe that rapidly acquiring registered users in this new market is a key to success of our business model and we will accelerate this push in Q4 2018. We expect revenue to be in the range of $140 million to $155 million. Together with our key channel partners we are planning for a strong holiday season and expect it will be more promotional than in prior years. The holiday period is no longer limited to a few days. We start in October with several targeted promotions and move on to the week's long selling period of Black Friday and Cyber Monday and finish it off with the December holiday push. With these activities we expect our GAAP gross margin to come in between 12.4% and 14.4% and our non-GAA gross margin to come in between 13% and 15% in the fourth quarter of 2018. As you would expect, given our consumer market focus, I'd like to remind everyone that we will see seasonality in our business as we enter the first half of 2019. We also plan to continue aggressively pursuing growth of our registered user base by promoting our products during the first half of 2019. Accordingly we would expect our non-GAAP gross margin percentage for the first half of 2019 will be in the low 20s before taking into account our estimated $4 million of one-time costs related to the recently introduced tariffs. We expect our GAAP operating loss will be in the range of 18.1% and 15.1% and non-GAAP operating loss will be in the range of 13% to 10% and our GAAP and non-GAAP tax expense will be approximately $300,000. Operator we're done with our prepared remarks and would like to take questions.

[Operator:]

Certainly. [Operator Instructions]. Your first question comes from the line of Adam Tindle from Raymond James. Please go ahead. Your line is open.

[Adam Tindle:]

Okay thanks and good evening. I just want to start a little bit on services obviously your market share and products are very strong wire-free battery life the base station concept can you may be just talk about the early learning's and services what are the key pain points for customers and how do you get to a point where services are differentiated the way that product is?

[Matt McRae:]

Yes, absolutely we rolled Arlo Smart now it's been about eight months or so since the original launch and we're seeing some great feedback as we mentioned on the call and very positive results. We've also done a lot of surveying around how people feel about signing up for the service and their experience afterwards. And I'll tell you it transforms the experience with the product at a fundamental level of greater than what we originally had thought. The day the best parts of the service that I think are resonating the most are in two or three areas one is in the interaction with events and notifications being able to use the notifications immediately to see what triggered an event and being able to filter those using our AI and computer vision around persons detection. What we announced today adds several more categories around computer vision including vehicle detection which was a top request and animal detection and package protection which could be very important in the holiday quarters people getting a lot of packages that's one area. The other areas I would highlight are around using the device as a security product and that time to response so the enhanced 911 feature is also a top driver of satisfaction in that. You can one touch call 911 anywhere in the world and you'll be routed immediately to the 911 center that's in your neighborhood. So I would say those are the main learning's and what we announced today was an add-on to all of the detection capabilities that are important as part of Arlo Smart including the smoke and CO2 alarm which allows you to detect if there's been a smoke or CO2 alarm event in your house the camera actually uses a microphone to listen in and can actually notify you that as well. So we see both of those areas as important ones how to respond to events in a system in a much faster way and be able to get authorities very quickly.

[Adam Tindle:]

Okay, that's helpful. And maybe just as a quick follow-up I wanted to touch on gross margin. I mean I think on a year-over-year basis is down close to 10% and Christie I think you said in the tariffs mainly hit you in Q1 no Q4, so I think that would leave basically just mix and pricing left over I guess I'm a little surprised to see revenue growth not accelerating with that level of gross margin decline is there a reason that we wouldn't -- why would revenue growth be decelerating year-over-year with such a decline in gross margin year-over-year. Thanks.

[Christine Gorjanc:]

Yes, and there's a little bit of tariff now that we've built into Q4 but the majority of that would hit Q1 but what I would really say as we talked about quite a bit over on the Road Show is normally we would have a new product in the market for all of Q4 and we separating from NETGEAR allowed us to have more R&D investment and a lot of those products you're going to see coming we've been talking about the spring reset. So really the majority of that promotion is that some of the products have been out there for quite a while and we don't have a big new one hitting in channel all of Q4 like we would normally have, like we had Pro2 last year I think introduced in September and I would say that's really the main reason.

[Operator:]

Your next question comes from the line of Rob Cihra from Guggenheim Partners. Please go ahead. Your line is open.

[Rob Cihra:]

Hi, thanks very much. Two questions if I could one just kind of housekeeping just to make sure Christie you said the -- you gave 1.2 million units and 1.4 million devices I just wanted to make sure I was clear on what the GAAP was between those two are units just cameras or do they include lights in our base stations and either? And then my bigger question is more the -- what were you talking about in terms of particularly Matt you were talking about the Arlo Smart sort of new, sort of packaging and pricing that you’re looking to do later in the quarter, I mean is that sort of just -- is that sort of a pricing thing I mean why it's just currently what's driving sort of a change given the fact you only really just launched it not that long ago, it's just kind of some things you've learned since then or is it sort of a structural change? Thanks.

[Christine Gorjanc:]

Sure. Rob, let me get your first question quickly. So it’s 1.2 million cameras, 1.4 million devices, the difference is basically light than it’s maybe few doorbell. We will continue to tell you what that is -- what that composition is as we continue the doorbell is now sitting on the shelf and as we roll that out, we will give more color on that. But that’s the difference there and I'll let Matt talk to the new business model.

[Matt McRae:]

Yes, so, and you've heard us talk a little bit about this on the main section of the call. Based on the success and the positive feedback of Arlo Smart, we are really doing two things, one is we're -- you heard us repeat that we’re going to drive registered users because we balance the pool of feature paid subscribers and then more pointed to your question, we will in this quarter be launching a new core product with a different bundled service package and that is to leverage our retail channel to further drive pay subscribers. So what you see there is instead of the basic service plan, you'll see a one-year bundle of Arlo Smart inside that purchase price and then there is a lot of survey data and research that we did ahead of time and it looks like a very positive combination to be able to drive subscriber growth and then in 12 months obviously drive renewal rates on that subscriber. Everything we've seen from our survey data and the experience and feedback we get from customers is when they spend an extended time with Arlo Smart, it really transforms user experience across the Arlo product line and they remain customers.

[Operator:]

Your next question comes from the line of Trip Chowdhry from Global Equities Research. Please go ahead. Your line is open.

[Trip Chowdhry:]

Yes, sorry. First of all, congratulations very solid quarter couldn't be better first quarter pretty good. Few questions here, we talked about Vision Intelligence and in the call on the first time we heard something called Audio Intelligence or Audio AI, can you explain a little bit what is behind this the technology and what kind of alerts or notifications does that enhance on Arlo Smart and then I have a follow-up question?

[Matt McRae:]

Yes, you’re right. So we've built an extended AI platform as part of our cloud platform that drives all of our low latency and IoT platform. And historically and in a lot of the announcement, we did say that was around computer vision which is using machine learning algorithms to drive from the image that is coming from the cameras, information of what’s in that image so that we can provide not only a more tailored notification to the end user for instance, person detected but allow them to filter and get smart about how they want to react to those notification and see what’s actually happening at whatever location and monitoring. Today, we have additionally announced leveraging of same technology, so it is still machine learning but instead of using the pixels from the video that's coming through the camera; we're using the wave forms in real time as they come from the camera to detect what's happening in the home. The feature specifically we announced today are smoke and Co2 alarm detection. And so if a traditional smoke alarm or traditional Co2 alarm goes off within the camera's microphone range, we can actually notify the end users specifically that they have a smoke alarm going off at their house based on using machine learning and artificial intelligence on the wave form that's coming from the camera microphone. Yes, go ahead.

[Trip Chowdhry:]

No, no continue please, sir.

[Matt McRae:]

You can see we’re leveraging AI and machine learning on the video path and the audio path and you’ve seen us add additional computer vision capabilities today. I would say as we mentioned in the call, you should expect us to kind of continually add more and more value to Arlo Smart over time. In some cases we made combined vision and audio into a single detection system.

[Trip Chowdhry:]

I think this is very good and interesting because I think many of your competiting products in the marketplace they don't have the microphone to capture the audio, many of those. So that differentiates you well. Secondly my question is regarding the paid subscriptions at 125,000 up more than 100% that's a very solid undertaking, what -- did we do any specific marketing plans, how did we achieve this and how should we think about percentage of subscribers, the percentage of your registered users becoming subscribers say over the next two to three years, any thoughts or color on that?

[Matt McRae:]

Yes, so in the quarter we did some promotional activities on for Arlo Smart but specifically it was just generating awareness and driving people into the free trial. So I'll give you for instance our pass to our registered users to fix them a trial are relatively efficient from an acquisition cost perspective. We -- when you out of box a new camera system in that user experience, we put you on a 30-day free trial right as part of that out of box experience. We also can do in/out messaging which we did in the quarter to let people know that Arlo Smart exists especially to our installed base and we have obviously the email addresses in a marketing database we can reach out to them directly. So very efficient path that we're using so far and you'll see us do that again in the given quarter as we've just launched or will launch very soon the updated Arlo Smart and which I'll make sure everybody understands that. So we were obviously very pleased with the growth we're seeing year-over-year which is also why we're focused on driving registered user growth, so that we can market to them, just on the paid service we're seeing -- we're seeing a very strong and positive feedback from that. As far as attach rate, we don't publish an attach rate to the service as far as registered users but I can tell you it is growing especially when we look at it from a cohort analysis but the best way to look at it today is if registered users went up 88% and the paid subscribers went up 105% over the same time period.

[Trip Chowdhry:]

Beautiful. Last question you have both invoked lot of curiosity among your customers and investors, you did mention that at CES show you will be announcing a completely new category, can you give some pointers would it be something that camera something that sound or any pointers that would be really useful for us without giving all the details?

[Matt McRae:]

We’re not going to release a lot of details except to say that it won't just be a normal camera, what we call our core product line, so we think it's a big announcement, we're going to wait until we get closer to the get closer to CES, we will announce what it is.

[Operator:]

Your next question comes from the line of Jeffrey Rand from Deutsche Bank. Please go ahead. Your line is open.

[Jeffrey Rand:]

Hi, can you talk a little bit about your marketing strategy going to the Holiday season and how you allocate between your distributors and to more of the direct end users as I know impacts your gross margin?

[Matt McRae:]

Yes, so predominately and Christine can talk about the numbers, predominantly our marketing spend is in the distribution channels, so it's contra revenue, I'll make a comment outside of that, you will see us promote a bit of obviously the new Arlo Smart and a little bit around our new doorbell inside the channel.

[Jeffrey Rand:]

Great. And --

[Christine Gorjanc:]

I mean I guess the only other color is yes, there is a lot of that that really obviously to distribution channels at the retail outlets and that and as you know we start planning for Q4 six months ago with Black Friday, Cyber Monday there's just carry week at Costco then there is all the holiday promotions. So we do work out deals with our retail partners quite a while ago as we go through those and I tell you some of the Flyers are probably already pointed in that as we move forward in to Q4 so always our most highly promotional quarter.

[Jeffrey Rand:]

Great, thank you. And just following up since you guys are so focused on driving user growth, do you think in the future you might be more willing to discount cameras more or provide a lower cost on cameras, so you can get more users?

[Christine Gorjanc:]

I think those are a couple of definitely things that we're looking at. I would say we are promoting more than we did a year ago and that is really to get that active registered user growth also and we do have a pretty robust line-up coming in next year. I think Gen 3 is our entry cam right now but I would imagine that camera is about three years old, we will have some new products coming out and they will definitely replace some of our current products and definitely more feature rich on all of those.

[Operator:]

Your next question comes from the line of Rob Stone from Cowen & Company. Please go ahead. Your line is open.

[Rob Stone:]

Hi, I had two or three quick questions if I may, the first one I wanted to go back to the new core product with the one-year Arlo Smart bundle, is that going to be a complete replacement for some equivalent system or are consumers in the channel going to see the possibility of I get disbundled with the Arlo Smart or I get the cameras with the limited free cloud storage and so forth, no service along side, I'm just thinking about the product positioning and is this sort of one of your several offerings or you going to basically be phasing in this one-year bundle approach across the product range?

[Matt McRae:]

I think it's best to look at this product as incremental to the core products you’re already seeing in the channel.

[Rob Stone:]

Okay. And that's I guess to test the series it's better to get people to pay more incentive for service later on.

[Christine Gorjanc:]

And I would say actually what we really want is we want them to use Arlo Smart because we really believe that once you use it, you like it, and you're going to want to keep it, so it definitely is a way to make sure that they are trying it out and using it and we believe they will become subscribers.

[Rob Stone:]

Okay. I had another question relative to the Audio AI. I think breaking glass detection is one of the other sort of obvious signals that the people would like to listen for how the system was performing or not at home, how big a challenge would it be to add that as an audio feature to Arlo Smart?

[Matt McRae:]

Well, I don't want to talk about potential future features. But I would say that like we're doing on the video AI and computer vision side, we are exploring obviously additional Audio AI and machine learning capabilities. And in often cases in our respect, we carefully balance both the system performance and of course the battery life which can change the -- some of the categories that we look into. But I think both on the computer vision side and on the audio AI capabilities, we're still relatively early in the roadmap and the capabilities of what the system can do.

[Rob Stone:]

Great. Then a couple of housekeeping questions for Christine, one is you didn't touch on separation expense which was segregated from the non-GAAP operating expenses, I think at one point we were expecting to see also some one-time transition costs which you were possibly going to include, so I just wanted to inquire if there are any sort of episodic items included in your non-GAAP expenses that are temporary sort of related to the separation?

[Christine Gorjanc:]

Sure. Looking at Q, okay when I -- so we did definitely break that out when we look at your guidance, so you can see that the separation expense of $3 million for Q4 and in Q3 let me look at that number on the separation expense. And it's probably [indiscernible] -- as regard to the TSAs those are actually embedded in the expenses that we are doing, we had TSAs what we Transition Service Cost for Q3 and they will be reduced in Q4 and they're embedded in the different line item and then you'll see those go away at the end of the year. And I would say there was $5.8 million in separation expense below the line in Q3.

[Rob Stone:]

Okay. And the last one then is just kind of a update on the progress towards the separation, I know there really is time you could do it I guess would be the end of this year which would give a nice clean view versus a clean channel on reporting for next year, so sort of how things are going towards having everything fully separated?

[Christine Gorjanc:]

It’s actually really going quite well. We had a nice plan in everything going according to plan, we are now on our own system and everything and as you could see the hiring is ramped up with 344 people and we have a lot of our folks that already moved into new facilities and everybody else will be moved out of the NETGEAR facilities right before the end of the year. So I would say as we enter into 2019, we will really not be relying on transition services and we will be truly and completely separate.

[Operator:]

Your next question comes from the line of Nat Schindler from Bank of America. Go ahead. Your line is open.

[Nat Schindler:]

Yes, hi thank you. Just a couple questions on the 2019 gross margin target you said for the first half of low 20s before the effect of China move-out, is that a new real run rate based on the level of contra revenue marketing you expect to be doing plus mix shift or could we expect a dramatic change there is anything really hitting that versus last year of that is short-term basis.

[Christine Gorjanc:]

No, I say it’s again we're being more promotional than we were in Q1 say take for example Q1 of 2018 we're going to continue to be more promotional even that is really our older products we were being promotional with those as we move ahead and coming in for the new ones that we expect to see on sprint reset and obviously beyond that too. So I think it's really more that combination of more promotional because some of the products are a little bit older as we go into the market.

[Nat Schindler:]

Okay. And you probably relayed and probably going to be the same answer but on Q4 how much of the difference in gross margin on a year-over-year basis or even a quarter-over-quarter basis is the 13% to 15% gross margin guidance you have for Q4 based on contra revenue marketing versus mix shift or the like.

[Christine Gorjanc:]

I would say it’s the majority of it is contra revenue marketing is absolutely how much we decide to participate in Black Friday and Cyber Monday and Charity Week and everything else. So definitely promotional and then also there is some frighten things in there as we bring stuff over which we traditionally have in Q4 but I’ll say the majority of it is we're participating heavily in the promotions, at the end of the day we want the registered users and this is -- if we want registered users Q4 is the absolute quarter to go get as many as you can and Matt, we did talk about we want to add 400,000 registered users this quarter which is more than we've added in any one quarter in the history of Arlo.

[Nat Schindler:]

Totally makes sense and so what -- should I expect you to do pretty much the same thing maybe off a different base level but the same type of effect on a Q3 to Q4 gross margin next year and the year after.

[Christine Gorjanc:]

I would tell you Q4 gross margin is always a bit of an outlier and it is how much we decide to participate in Black Friday and Cyber in that and I say so a little bit exasperated by again that the product line being a little bit older if I have a brand new product out in Q4 you can bet I'm not going to be promoting that.

[Matt McRae:]

And I would add that on a strategy basis we are seeing very positive feedback and from the growth of Arlo Smart and so we'll continue to push for those registered users. As we continue to see a good return on that investment as we go forward, so some of this is a new focus for us on growth to drive those registered users which helps me come down into the future pool of paid subscribers. And also like I said we're launching a new -- kind of a new business model with that new core product with the bundled year of Arlo Smart which will be interesting to see how that affects the market as well.

[Nat Schindler:]

Makes sense and one last question may be just as a back ended way to ask you what you're going to announce at CES, but one of the competitive offerings have you seen that you lack and are I think are good ideas for the market, what are the competitors have that you don't right now that you would love -- that you think would be you that are valuable?

[Matt McRae:]

Well, if we look back I think having a specific solution for the entryway was important I mean our doorbell just started selling; I think on Sunday of this past week, we're focused on a lot of services. But if I go any deeper looking forward, you would be able to see my roadmap. So I can't answer it directly but in general from a strategic perspective Arlo is obviously the number one market share in monitoring and you've seen us add a lot of services like enhanced timeline one and the smoke and CO2 alarm and starting to spend Arlo into a broader security landscape, let alone eventually maybe Smart home we talked a lot about on our Road Show. So the products that you'll see come from us will align with that strategy that we showed in the S1 and talked about on the Road Show around monitoring going to full home security going into the Smart home over time.

[Operator:]

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

[Matt McRae:]

Thank you, Operator. Thank you everyone for joining us for our first earnings call today. We’re very pleased with the growth that we delivered in revenue and paid subscribers for the third quarter of 2018. We also have a lot to look forward to in Q4 with an updated Arlo Smart on its way, a new product and a new business model coming into market. Looking out to 2019, we have a robust roadmap of products, features and AI capabilities that I look forward to updating you on in the future. If you’re attending CES in January, then I encourage you to stop by our booth for a preview of what’s coming next. Thank you again.

[Operator:]

This concludes today’s conference call. You may now disconnect.