Arlo Technologies Inc

NYSE:ARLO

Earnings Call Analysis

Arlo Posts Record Earnings and Strong Growth

Arlo Technologies showcased a strong financial performance for Q3, with a 16% year-over-year increase in non-GAAP gross profit, hitting $44 million due to their booming Services business. Non-GAAP operating expenses were markedly down from the previous year, attributed to cost-saving initiatives and suspended brand campaigns, with a minor increase in team size to 353. The quarter saw a record non-GAAP net income of $9.6 million, or $0.09 per diluted share. Free cash flow for Q3 stood at $7 million, totaling $28 million year-to-date, significantly surpassing last year's figures. Q4 revenue is projected to be $129 million to $139 million, refining the full-year guidance to $485 million to $495 million. Service revenue is expected to grow by approximately 45% compared to the previous year, with non-GAAP service gross margins anticipated to hit 75% for 2023.

Subscribers and Revenue Growth

Arlo Technologies has experienced significant growth with its subscriber base increasing by 50% to 2.5 million and its annual recurring revenue (ARR) growing by 60% to $200 million. This expansion is coupled with a rise in average revenue per user (ARPU) and a lifetime value (LTV) now at $700 per subscriber.

Innovative Product Launches

The introduction of the low-cost Essential 2 platform has been a key strategic move, representing the company's largest product launch and playing a crucial role in the quarterly revenue reaching $130 million, at the high end of the guidance range. Additionally, a new Total Security Subscription offering has been launched at $9.99 per month, which simplifies consumer entry into the security solutions space and is expected to foster further adoption.

Financial Performance

The third quarter saw Arlo deliver a record non-GAAP earnings per share of $0.09, with a noteworthy operating margin of 6.5%. Such figures underscore the firm's enhanced fiscal health, reflected in a $65 million year-over-year increase in free cash flow for the first nine months of the year, outpacing the expectations outlined in the company's long-range plan.

Guidance and Strength of SaaS Model

Arlo has expressed confidence in the strength and resilience of its SaaS model by revising its Q4 and full year guidance upwards, signaling anticipation of continued operational and financial success.

Services Revenue and Operating Metrics

Service revenue continues to become a more significant portion of total revenue, almost 40% compared to 28% in the previous year. This shift has greatly contributed to the elevated non-GAAP operating profit of $8 million, or 6.5% operating margin. Service revenue for Q3 was a record $51 million, up 44% year-over-year, driven by substantive growth in paid accounts, now totaling nearly 625,000 added over the past three quarters.

Profitability and Gross Margin

Arlo reported a non-GAAP gross profit of $44 million in Q3, a 16% year-over-year increase with a non-GAAP gross margin of 34%, which is an improvement of 400 basis points from the same period last year. Non-GAAP service gross margin stood at 74%, slightly down from 75% in Q2 2023 but up significantly from 67% in Q3 2022.

Q4 Outlook and Fiscal Year Expectations

For Q4, Arlo projects revenue to be between $129 million and $139 million, positioning the full year revenue estimate at $485 million to $495 million. Non-GAAP net income per diluted share is expected to be in the $0.06 to $0.12 range, indicating a robust closing for the fiscal year. Service revenue is projected to grow approximately 45% over the last year, reinforcing its burgeoning role in overall revenue and profitability.

Earnings Call Transcript 2023-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. [Operator Instructions] I would now like to turn the conference over to Tahmin Clarke. Please go ahead, sir.

[Tahmin Clarke, executive]

Good afternoon, and welcome to Arlo Technologies' Third Quarter 2023 Financial Results Conference Call. Joining us from the company are Mr. Matthew McRae, CEO; and Mr. Kurt Binder, CFO. The format of the call will start with an introduction and commentary on the business provided by Matt, followed by a review of the financials for the third quarter, along with guidance for the fourth quarter provided by Kurt. We will then take your questions. If you've not received a copy of today's release, please visit Arlo's Investor Relations website at investor.arlo.com.Before we begin the formal remarks, we advise you that today's conference call contains forward-looking statements. Forward-looking statements include statements regarding our potential future business, operating results and financial condition, including descriptions of our revenue, gross margins, operating margins, earnings per share, expenses, cash outlook, free cash flow and free cash flow margin, guidance for the fourth quarter of 2023, the rate and timing of paid subscriber growth, the transition to a services first business model, the commercial launch and momentum of new products and services, strategic objectives and initiatives, market expansion and future growth, the effect of our brand awareness campaign on 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 the most recent annual report on Form 10-K and quarterly report on Form 10-Q. Any forward-looking statements that we make on this call are based on assumptions as of today, and Arlo undertakes no obligation to update these statements as a result of new information or future events.In addition, several non-GAAP financial measures will be discussed on the 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.

[Matthew McRae, executive]

Thank you, Tahmin, and thank you, everyone, for joining us today on Arlo's Third Quarter 2023 Earnings Call. Arlo delivered an outstanding performance in Q3 across both financial and operational measures. The decisions that we made 12 months ago in anticipation of the shifting market landscape, and consumer sentiment were on target and have positioned Arlo for success, despite the challenging macro environment.Our first decision focused on lowering the barrier of entry into the Arlo ecosystem. This led to us rebalancing our pricing across hardware and services by lowering upfront hardware costs and increasing recurring service prices. Implementing this change allowed us to maintain our robust product sales, which in turn drove our highly profitable and predictable services business, despite a weakening consumer environment. The outcome of this decision is clearly illustrated in our outstanding results.After crossing over 2 million subscribers earlier this year, Arlo now has 2.5 million subscribers and is growing paid accounts at roughly 50% year-over-year. Additionally, annual recurring revenue, or ARR, grew 60% year-over-year to $200 million. This robust paid account growth comes along with increased ARPU and an LTV that is now $700 per subscriber. And as a reminder, our customer acquisition cost is roughly $100, which means our LTV to CAC ratio is a stellar 7.This morning, to further bring down the barrier of entry, Arlo launched our new Total Security Subscription offerings in partnership with a firm, which combines hardware and service solutions into a single, low monthly payment. Pricing for this package starts at just $9.99 per month, including professional monitoring and dramatically lowers the cost of entry for consumers in the need of a security solution. This new offering represents an outstanding value proposition and compelling opportunity for those customers looking for their first security system or upgrading from a traditional security system where they are paying too much for antiquated technology and poor service.The second decision that we made 1 year ago to counter the initial macroeconomic indicators was to change our normal roadmap cadence and prioritize developing a new low-cost Essential platform. The team worked tirelessly over the last 12 months to develop our new Essential 2 platform, which includes significant user experience enhancements, video quality upgrades, battery life improvement and new features, all at a substantially lower price. In fact, a significant portion of the innovation cycle came from the close hardware integration and resulting cost reductions with our supply partners that enabled Arlo to target lower-priced segments with a superior product and user experience.The launch of Essential 2 also demonstrates our operational excellence across our supply chain capabilities. This is the largest product launch in Arlo's history. We ramped our production to 800,000 units across more than 40 SKUs in less than 8 weeks in order to support a robust holiday sales plan in collaboration with our channel partners. This strong execution contributed to our Q3 revenue of $130 million, which is at the high-end of our guidance range. Additionally, we generated record non-GAAP earnings per share of $0.09, which represents an operating margin of 6.5%, another record for the company.Stepping back and comparing the first 9 months of this year to last year, free cash flow is up about $65 million. This strong financial performance puts us well ahead of the long-range plan we communicated to investors at the beginning of last year.As I look across our channels and even recent promotional events like Amazon's big deal days, Arlo is seeing continued resilience in consumer demand that defines the broader economic trends being reported. Rising safety awareness, concern about crime and our pricing strategy have continued to successfully counter any macroeconomic headwinds. Throughout the year, we have gained share and coupled with the Essential 2 launch, Arlo could not be positioned any better to deliver a successful holiday season.The result of those decisions speak for themselves. As a result of strong operational trends, we are raising our guidance for Q4 and the full year. Our results and expectations for continued operational and financial success highlight the inherent strength and resilience of a true SaaS recurring revenue business. And while it may sound counterintuitive given the volatile times in which we currently operate, Arlo is better positioned than it's ever been and boasts the future that is only getting brighter with each quarter as we continue to execute our plan with a dogged determination and focus.We know the important role we play in our users' lives and there is a clarity of purpose, coupled with a consistent cadence of execution towards our key goals of paid account growth, expansion of profitability and ultimately, the creation of additional shareholder value.And with that, I'll turn it over to Kurt.

[Kurt Binder, executive]

Thank you, Matt, and thank you, everyone, for joining us today. I will start by sharing some financial details and an overview of the business for Q3 2023. Revenue for the third quarter came in near the high end of our guidance range at $130 million, up $15 million sequentially and slightly higher on a year-over-year basis. While revenue was relatively consistent year-over-year, the composition of that revenue continues to change dramatically. In the quarter, service revenue was almost 40% of total revenue, while last year it accounted for 28% of total revenue. This shift is reflective of our services first approach, as well as the impact of our new pricing strategy.I want to highlight the strength of our services revenue and ARR growth which helped deliver solid revenue performance and contributed to Arlo generating a record non-GAAP operating profit in Q3 of $8 million or 6.5% operating margin. Our service revenue for Q3 was another record at $51 million, an increase of $15.6 million or 44% year-over-year. This growth was driven by our subscription price increases and the addition of almost 625,000 paid accounts over the past three quarters. This number does include some catch-up of bear shore accounts that were underreported, as discussed on our last call.Again, we continue to expect the normal growth in paid accounts to remain in the 170,000 to 190,000 range per quarter. Our installed base continued its strong growth trajectory and reached 2.5 million subscribers in Q3. As mentioned earlier, services accounted for nearly 40% of our Q3 total revenue and importantly, represented 86% of our total non-GAAP gross profit as our pricing strategy is clearly designed to maximize product sales, but with an intent to drive growth in our highly predictable and profitable services business.Our record operating profit, up $12.6 million from last year, stands as another proof point that the strategy is working. Additionally, we're excited to have reached ARR of $200 million in Q3, up about 60% year-over-year, providing another solid proof point of the tremendous power of the recurring revenue in our Services business.Product revenue for Q3 was $79 million, which was up over 20% sequentially and down 15% year-over-year. During the quarter, we shipped a total of 1.3 million cameras worldwide, compared to 1.2 million in the prior year period. Product revenue was impacted by a slight increase in shipment volume, but more so due to declines in average selling prices driven by a deliberate shift in our pricing strategy and mix in global product assortment.In the quarter, approximately $50 million or 38% of our revenue originated from our international customers. Our EMEA results were impacted in the past few quarters as our largest partner continued to constrain inventory levels, a cycle other channel partners went through in previous quarters. We remain confident this is not an end market demand issue and expect this near-term response to macro conditions in the region to moderate over time.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 distributed earlier today. Our non-GAAP gross profit for the third quarter was $44 million, up 16% year-over-year. This resulted in a non-GAAP gross margin of 34%, up 400 basis points from 30% in Q3 of 2022. The year-over-year increase in non-GAAP gross profit was attributable to the growth in our Services business. The improvement in non-GAAP Service gross profit was driven by growth in our subscriptions and planned pricing, coupled with cost optimization.Non-GAAP service gross margin for the quarter was 74%, slightly down from 75% in Q2 2023, and significantly up from 67% in Q3 of 2022. Non-GAAP product gross margin for the quarter was 8% and consistent with the previous quarter as well as our guidance provided in March of this year. Furthermore, we are very pleased that once again our Services non-GAAP gross profit exceeded our non-GAAP operating expenses in the quarter, a critical financial achievement we expect to continue to build upon in the future.Total non-GAAP operating expenses for the third quarter were $36 million, slightly down sequentially, but significantly down year-over-year. The year-over-year decrease is primarily attributable to the suspension of our brand awareness campaign just after Q3 of last year. The non-GAAP operating expenses for the first 3 quarters of 2023 were markedly better than our expectations and reflect the cost savings initiatives implemented last year as well as a disciplined approach to discretionary spending throughout 2023.Our headcount at the end of Q3 was 353, which represents a slight change from 345 team members at the end of Q2 and 360 team members in the same prior year period. In Q3, we posted non-GAAP net income of $9.6 million. Our non-GAAP net income translates to earnings per diluted share of $0.09, a record for Arlo and at the high end of our guidance range.Regarding our balance sheet and liquidity position, we ended the quarter with $126 million in available cash, cash equivalents and short-term investments. This balance was up over $2 million sequentially and demonstrates the solid capital position that Arlo is in right now. We are pleased to report that we generated approximately $7 million in free cash flow in Q3 which represents free cash flow margin of 5%, an improvement driven by our increased profitability and solid working capital management.Additionally, our year-to-date free cash flow was a remarkable $28 million throughout the first 3 quarters of 2023 or an almost $64 million improvement over the same period last year. Our Q3 inventory balance ended at $53 million, up $14 million from Q2 2023 as a result of the launch of our Essential 2 camera portfolio and in line with our expectations.Inventory turns in Q3 were at 5.5x, down from 6.1x in the last quarter. Our new product launch will enable us to remain highly aggressive with our product pricing strategy, particularly through the holiday season and into 2024. We remain focused on maintaining appropriate inventory levels to effectuate a smooth product transition with our retailers and partners. These factors have impacted our inventory balance and thereby, our ability to generate similar levels of free cash flow.And finally, our accounts receivable balance was $70 million at the quarter end with Q3 DSOs at 49 days, down from 59 days from the same period last year. We will continue to monitor our working capital balances in line with our revenue and forecasted consumer demand levels with a focus on maintaining a solid balance sheet and liquidity position in the future.Now, turning to our outlook. We expect the fourth quarter revenue for 2023 to be in the range of $129 million to $139 million or $485 million to $495 million for the full year, thereby increasing the midpoint of our full year guidance. We expect our GAAP net income loss per dilutive share to be between a loss of $0.05 to income of $0.01 per share and our non-GAAP net income per diluted share to be between $0.06 and $0.12 per share for Q4 2023. Service revenue is still forecasted to grow at approximately 45% over last year thereby becoming a much larger portion of our overall revenue and profitability mix, and we expect non-GAAP services gross margin to be in the range of 75% for 2023.And now I'll open it up for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Scott Searle with ROTH MKM.

[Scott Searle, analyst]

Nice job on the quarter, guys. Kurt, I apologize bouncing between calls, but I was wondering if you could talk a little bit about the ARPU mix in the quarter between strategics and otherwise? It looked like it was a little bit down sequentially. I'm wondering if there's anything to read into that in terms of pricing rebates or otherwise? And how we should expect that to trend over the next couple of quarters?

[Kurt Binder, executive]

Yes. Scott, welcome to the team. Thanks again for your support. I'm glad to have you on the call today. Great question. We're still very pleased with the way that our ARPU is trending. We've communicated in the past that when you look at our retail channel, our ARPU trends in the range of $11.50, which is up year-over-year, driven much because of our pricing strategy that we employed earlier this year. So that's been trending very well.The ARPU on the strategic account side is heavily driven around the actual revenue model. As we've mentioned in the past, it's more of a cost consumption SaaS-based pricing type model. So that tends to be lower than our retail channel ARPU, but it's right in line with our expectations. What we are seeing though is that in terms of the overall subscriber mix, subscriber mix has been mixing up slightly higher on the strategic account side. So that might have a trend of impact in our overall blended ARPU, but it's still in line with expectations, and it's still trending in a favorable way.

[Scott Searle, analyst]

And just as a follow-up, I'm wondering if you could talk a little bit about attach rates in terms of paid accounts, if we're seeing any sort of divergence on that front or things are consisting -- progressing in line with expectations? I guess as part of that now, the more advanced 24/7 security monitoring opportunity for you, I'm wondering how you see that fitting into the picture, what the broad-based expectations are for that?

[Matthew McRae, executive]

Yes, this is Matt. I'm happy to welcome you as well to the call, Scott. From a security perspective, the security system, I mean, we're very excited about that. I'll just kind of reference the announcement we made this morning around the Total Security Subscription package, which is really exciting. It combines the service and the hardware together in one low monthly payment. We're doing that with our partner firm. And that's us positioning the security system which comes with higher ARPU over time in that relationship in a way that consumers are kind of used to buying that already, especially from a direct customer. So yes, we're very excited about that. I'm trying to remember what was the first part of your question?

[Scott Searle, analyst]

Well, Matt, just in terms of attach rates...?

[Matthew McRae, executive]

Attach rates. Yes, sorry. Yes. So we haven't seen any big changes in attach rates or conversion rates. And just to remind everybody, we actually track both. So attach rates for us is a measure 30 days after the initial trial is done. We take a quick snap and look at the attach rates, and that's roughly 50%. And then we continue to follow those cohorts all the way up to 6 months at later, and that's what we call our conversion rate. Both of those metrics, and I will even add churn to this bucket, are still extremely consistent quarter-over-quarter. So we're not seeing any big swings there at all.

[Operator]

Your next question comes from the line of Jacob Stephan with Lake Street.

[Jacob Stephan, analyst]

Congrats on the quarter. I guess the first question would kind of be focusing on the Service gross margins here. When I look at -- Service gross margins declined sequentially. Is there anything specific you can really point to as the reasoning? And maybe just kind of reiterate why you think you could hit that 75% full year target?

[Kurt Binder, executive]

Yes. Jacob, glad to have you on the call. Yes. So as you pointed out, overall Services gross margin quarter-over-quarter did drop slightly. We were at 75% on a non-GAAP basis. Last quarter we were at 74%, 74.1% this quarter. A lot of that was driven by the Services revenue mix in the quarter. As we've talked about in the past, we do have quarters where NRE is a bigger portion of our overall revenue and our NRE service revenue tends to be at a lower margin profile. So that will happen quarter-to-quarter. You may see some fluctuations.But I will say -- and I emphasize that we're still very extremely excited about how we're executing on the Services business. As we mentioned previous quarter, we reiterate again this quarter that we expect that Services business to be up 45% year-over-year, and we still are targeting for a full year to be in that range of 75%. So that's our target for the year.

[Jacob Stephan, analyst]

And so, if I recall correctly, the guidance for service revenue growth year-over-year was raised slightly last quarter, and I think it equated to something around 48%. So is this kind of just a resetting of expectations or I guess just a little [ light ] down ticker in [indiscernible]?

[Kurt Binder, executive]

No, in the last quarter -- yes, we definitely guided to -- in that $200 million range for sure. I don't know if we actually cited the actual percentage growth, but what we see from -- when you look at last year's full year Service revenue versus this year's full year Service revenue, we are, to be exactly be up probably 45%. That's what we're targeting.

[Jacob Stephan, analyst]

And just one more on the kind of overall competitive environment. I mean, ADT reported recently, they're kind of refocusing on the core business, launching some newer kind of lower ASP products. Do you see any new kind of competitors or any new competition from ADT or any of the other guys in the market today?

[Matthew McRae, executive]

It's a great question. We are actually seeing some more consolidation and actually some brands come out of our major channels, which I think provides some opportunity on the upside. So if I step back and just provide a little bit of commentary on what we're seeing across both arlo.com, but more specifically our retail and direct paid channels like the big retailers, we positioned ourselves, I think, extraordinarily well based on our pricing strategy and some of the things we talked about in our prepared remarks. And we're expecting a great holiday season.I mentioned in the prepared remarks that we had an above forecast or strong Amazon big deal Day, which was in the October time frame. I'm happy to report today, too, that Walmart launched its AE event, which is its annual event, which is kind of its biggest promotion in Q4, for its holiday period yesterday. Arlo is the flagship product for that in this market segment. And we've got about 1.5 days of data under our belt, and it's actually stronger than expectation as well.So we're seeing, like I mentioned before, consistent, resilient demand based on how we're executing in the channels. And we're starting to see in certain channels, some of our competitors actually be pulled off the shelf as the retailers are concentrating on those brands that are actually investing in the channel and actually driving growth for them. So, yes, there's some noise about certain products being launched here and there, but I would say the overall trends we're seeing in our channels are actually around us gaining share -- us gaining [ mind ] share with the channel partners and seeing some of our competitors actually come off the shelf.

[Operator]

Your next question comes from the line of Adam Tindle with Raymond James.

[Adam Tindle, analyst]

Congrats on the $200 million of ARR, really nice milestone to hit there. I wanted to start, Matt, on net new paid subscribers. I think it was just under 200,000, 197,000 for the quarter. And if we compare that to net new registered users, it looks like the attach rate that we could see is a little bit lower than it's been in a couple of quarters. And I wonder if there's maybe some rationale behind that? And then secondly, that [ 197,000 ] number is also a little bit lower sequentially. I think it's above your typical targets, but -- and you had some one-timers in there. Just the -- what looks like the implied deceleration sequentially, and comments on that, and the implied attach rate on why it might look a little bit like a deceleration quarter on quarter?

[Matthew McRae, executive]

Yes, exactly. Yes. Great question, Adam. And actually, the 2 questions you have are actually related. So I'll remind you in the previous, I guess, 2 quarters we commented that Verisure, one of our top partners, is actually doing a bit of a catch-up on the paid account numbers, right? Now from a revenue and our perspective, we're charging them correctly, but they had a firmware issue in one of their regions where it wasn't incrementing the actual paid account level.So if last quarter, which was closer to [ 240,000 ] and change from a net add perspective. If you backed out that, it was right in the [ 170,000 ] to [ 190,000 ] range per quarter. So call it the [ 180,000 ], [ 185,000 ] roughly, if you back that out. This quarter, same thing. They added fewer of a catch-up. So we were closer to [ 200,000 ], but the catch-up was probably closer to [ 10,000 ] to [ 15,000 ], again, putting us right in that [ 170,000 ] to [ 190,000 ] range. So removing that noise from just the catch-up actually you're seeing consistent growth in paid subscribers as we're going forward.I will say that I think we'll see this continue. So they are not done cleaning up and doing firmware upgrades in that region to get the numbers to kind of increment correctly. And it's just an aberration on that single number, but it does affect certain calculations if you're dividing paid accounts for ARPU and some of those things. So I [ can't ] shift things around a little bit.In reality, we're going to see, I think, still stick with that [ 170,000 ] to [ 190,000 ] range as we go forward. You may see a bigger catch-up number. Next quarter, maybe it's smaller. I think we probably have about 2 to maybe 3 more quarters of catch-up at most before we can get back to just kind of the normal run rate of business. But again, if you back out that kind of fluctuating catch-up from that one region in Europe, the paid account growth is actually perfectly consistent quarter-over-quarter and exactly within the range we've been talking about.

[Adam Tindle, analyst]

And then just as a follow-up, the pro monitoring release. Obviously, excited to see that. It's been a long time coming. Just curious if you could comment on -- you've had a long time to think about this, how you're looking to differentiate with that platform? There's a number of these offerings out there, how you differentiate? And then Kurt, if you could talk about the financial impact? I know it's probably fairly small right now. But if that goes to a bigger part of the business, what would it do to the financial profile?

[Matthew McRae, executive]

Yes. So the total subscription, what we call Total Security Subscriptions is a relatively unique offer, especially in the DIY space, right? We are basically underneath financing the hardware and the service together over 36 months, but it's being presented to the end user as a subscription because we'll roll them into a subscription on the 37th month. So it is seen as -- from an offering perspective as a single low monthly payment, no upfront cost and you're getting both the hardware and the professional monitoring for that.If you click through the website, you'll see there's actually 3 [ tiers ], which is also interesting. So we have a starter pack that starts as low as $9.99 per month with professional monitoring, and then it goes all the way up to a more advanced pack that actually includes a full system plus cameras, multiple sensors and everything else. So it's got a wide offering range, and it's starting at a very aggressive price point and offer at least in the DIY space is very unique.One of the reasons we're excited about it is it presents the solution very much in a similar fashion and a very competitive fashion against some of the more traditional security vendors that are out there. And there's roughly 20 million to 25 million households that have old traditional security at much higher monthly payments and here's a solution that says, we can not only lower your monthly payment, but there's no outlay for hardware. So the transition over -- is actually very easy for the end user.So that's the thought behind it. And it's great. We've already got people signing up, which is great, even though we just launched a couple of hours ago. And so we're excited by that. We'll see how it goes and then we're hoping to lean in even further next year into that type of offering in the market.

[Kurt Binder, executive]

Yes. And then Adam, in terms of its -- the overall operating model and the financial profile, it's actually very attractive for us. I mean, Matt, I think, talked about it in the last quarter that we're offering 24/7 monitoring type service, but it gives us the ability in our overall portfolio of service plans to uplift our subscribers into a higher plan. And typically, that higher plan is almost 60%, greater than our overall blended average. So we see it as a -- an operating model that is very healthy that allows us to expand ARPU and expand ARPU over time.The great thing is, right now, the Total Security Solution, we're providing this through our direct-to-consumer channel. And therefore, our profitability is much higher. Now we might experiment in getting into other channels with a similar type offering. But right now, it's a very healthy, profitable channel for us, and we look to allow that to help us drive ARPU expansion over time, while we're selling it through our direct-to-consumer channel.

[Adam Tindle, analyst]

Just a quick clarification, Kurt. I just hear a lot of the financing component behind this. Could you just double quick on how you went about looking to protect ARLO? Is there a recourse to you for…?

[Kurt Binder, executive]

Great question. And the answer is no. That's what was so important about building this partnership with the firm. When we started working on this several months ago, we wanted to make sure that, first, the model would resonate with consumers and be over a nice 36-month period. But the great thing about this type of arrangement is we ARLO get paid upfront for the total package, and then they service and take the risk associated with the credit over that 36 months. So in our case, we have very little to no recourse around credit liability, and we get cash upfront, so it improves our overall free cash flow. What we want to focus on though is as we get to the 36-month term is what can we do to not only extend that contract with the customer, but also potentially get more services, more hardware bundled for the next phase of that relationship. So, all good in terms of balance sheet and credit risk standpoint.

[Operator]

Your next question comes from the line of Hamed Khorsand with BWS Financial.

[Hamed Khorsand, analyst]

Could you elaborate on your holiday sales plans? Are you -- specifically about inventory, are you over expressing on the essential side or it's going to be low price point items? Or is it a balanced mix?

[Matthew McRae, executive]

Yes. So the -- it will lean into definitely the new product launch, which is our new Essential 2 product. And I think that's a match of what we see just happening in the macroeconomic environment. So we're meeting the consumer where they are. From a unit perspective, it will be probably our largest quarter as a company from a holiday perspective. So we're excited by it. The plan is multichannel. I already mentioned the activity we had at Amazon earlier in the quarter. The Walmart deal is live as of yesterday. And you'll see some more unfold, obviously, through November and the beginning of December. It's probably the most robust holiday plan we've ever had. And it will be leaning -- as it usually does, leans into the most recent or the newest product at launch, which this year is essential too.

[Kurt Binder, executive]

And then from an inventory perspective, I mean, as we are heading to fourth quarter right now, as we communicated, we're sitting in the $53 million to $54 million range, which, frankly, is a very comfortable level for us. Now we will be stocking up a bit in the early part of Q4 with the ability to replenish over time as these promotional campaigns execute with our retailers. So I think we're well situated on our side from an inventory level. And we feel like the retail channel themselves, those retailers are in good standing as well. So I don't expect any concerns of meeting the demand. The demand seems to be evident and present. We'll have sufficient supply, and we'll monitor it throughout the fourth quarter and make sure that we set ourselves up for success heading into Q1 of next year.

[Hamed Khorsand, analyst]

And when looking into Q1 of next year, with the 50% conversion rate, how much of a significant move do you expect in the retail ARPU?

[Matthew McRae, executive]

The retail hardware or retail service?

[Hamed Khorsand, analyst]

No, the service ARPU, right? Because you're giving away 90 days.

[Matthew McRae, executive]

Yes. Actually, our new -- yes, so our new trial is actually 30 days. So some -- where it used to be relatively easy to take the entire volume, shipped volume, our POS volume in Q4 and say that will be Service revenue in Q1 because of the 90-day free trial. As we've migrated to a 30-day trial, it's a little [ blurrier ]. So some of the sales -- hardware sales in Q4 might see some increased account activity in Q4, some will actually be in Q4 and spill over into Q1. Holiday quarter Q4 always brings in some other timing variances. A lot of people buy products. And even if they buy in October, they stick it under the tree and don't open it until the end of December, potentially early Q1. And so there's some shifting there.So from an ARPU perspective, we're not expecting big shifts in ARPU. What I would say we're looking forward to is Service revenue lift from potentially having more new households formed over a robust holiday period. And that's -- but that's some of the normal seasonality I think we've always had in our business. It's just -- it's a little blurrier as we move to a shorter free trial period.

[Operator]

There are no further questions at this time. This does conclude today's conference call. Thank you for joining. You may now disconnect.