Alarm.com Holdings, Inc. (ALRM) Earnings Call Transcript & Summary

Thank you, everyone, for joining us. My name is Brian Essex. I'm Goldman Sachs' security software analyst. With me today I have Steve Valenzuela, who is the CFO for Alarm.com. So thank you for joining us. I do want to say a couple of things upfront. So one is that we are in a quiet period. So we can't really discuss fundamentals and forward-looking...

Financials like that...

Financials and stuff like that.

Yes.

So we're going to be respectful of that. And also because of that, we won't do Q&A from the audience. So hit them up afterwards. And it's very bothering when he steps off stage, but that way we're not responsible for those conversations. So Steve, thank you for joining us.

Great to be here. Thanks, Brian.

Maybe a great place to start off because it's a little bit of a different business model and a bit of a history behind how the company was founded. So -- perhaps, if you can give a little bit of background of the idea behind the company? And how it was founded? And how you've gotten to where you are today will be pretty helpful as a little bit of context?

That's great. Yes. It's actually a very interesting story of how Alarm.com was started. Some of you may have heard the story. But before I get there, Alarm.com is a lot more than just an alarm system. It's actually an interactive system. It's actually the operating system for the smart home. And if you look at the way we go to market, it's actually very unique, as Brian talked about. We actually go-to-market through over 8,000 service providers that are independent businesses that really provide security solutions, and that's expanding with the event of the IoT, with all of the smart devices that are out there. And so when you think of Alarm.com, and you'll see, as we talk about today, it's a very broad offering, a lot of verticals, horizontals as well. There's a lot of capability. But let me talk a little bit about how Alarm.com was started. And as I said, it's -- I think it's a very interesting story. So Steve Trundle was the CEO -- CTO of MicroStrategy, and he was actually getting an alarm system installed, and he was asking the alarm installer, "What happens if somebody cuts this wire?" Well, the guy says, you have no alarm system. So Steve, being a technologist, realized that there's a lot of potential here to come up with a system that is a lot more robust but also, being a technologist, realized that the alarm system has a lot of value even when there isn't an alarm or when there isn't an active state occurring, right? So there's a lot of potential of being able to interact with your alarm system. So at MicroStrategy, Steve actually incubated Alarm.com, that was around 2001, and really built the team within MicroStrategy. And turned out that MicroStrategy had bought all these dotcoms in the late '90s, and Alarm.com was one of the dotcoms. So to kind of make a long story short, from 2001 to 2009, Steve and a team incubated, within MicroStrategy, Alarm.com. The company saw good growth. Around 2009, Alarm.com was spun out with ABS Capital to be a private company, out of MicroStrategy. Around 2010, then Alarm.com started signing up all these dealers. And it really took a number of years to really get all the dealers signed up. It was around from 2012 to 2014, we went from -- we got to about 1 million subscribers, and then we got to about 2 million subscribers. Today, we have over 6 million subscribers, and that's all a result of having all these dealers out there that are actually selling core dotcom. What happened as well is around 2010 -- 2008, Apple came out with the interactive iPhone and Alarm.com was one of the first apps on the App Store. So that was pretty interesting. And when you think about what Alarm.com does is we take a security system, the plain old security system that you go home and you punch in your control pad, we made an interactive security system. So meaning that you can actually use your smart device, so it kind of all coincided with the smart -- evolution of the smart device, the smartphone, your iPad, to be able to interact with your alarm system. So even when your alarm system isn't active, you can see what's happening in your property, you can see what's happening around your home, you can see and monitor when your kids are coming home from school. There's a lot more capability beyond just the alarm system itself. So that's kind of the evolution of Alarm.com. A lot of innovations along the way. One of the innovations was converting the system, as I talked about, from a landline system to a cellular-based system. And in fact, we invented the radio module, which actually goes into the control panel. So when you look at a typical security system, you have a control panel, typically it's in your faucet. And in the old days, it was all hooked up to a landline. Today, because of Alarm.com, it's hooked up to a cellular connection. So if the landline goes down and the cellular goes down, there are backup as well. So it makes the alarm system very robust for the end subscriber.

That's really helpful. And maybe we can think about the business model from a reporting segment perspective. Your SaaS and license revenue in 1 bucket and your hardware in another bucket. What is the go-to-market strategy? And how much of the company is software versus hardware? How do you anticipate that will trend going forward?

So if you look at the -- if you look at our profile, about 70% is SaaS recurring revenue. The other is hardware. We really use hardware as an enabler to drive SaaS. SaaS, our margin is about 85%. Hardware, typically the gross margin is 18% to 20%. And over the last year or 2, what's really been driving hardware has been video. We came out with video analytics about a year ago, which really makes the video systems a lot more smart, and that's really driven a big uptick in hardware sales, mainly driven by video cameras and video doorbell. And so when you look at our financials, we have Alarm.com segment, as you talked about, we have the Other segment. And in fact, within the Other segment, it expands the Alarm.com's solution to unattended access, vacation rental property management. One of our businesses we have in the Other segment is called PointCentral. And what they do is they actually offer the system to property managers, to rental properties. Invitation Homes is one of our big customers there. They have like 70,000 rental properties, and they use our solution for unattended showings. So if you have a rental property, you can actually provide electronic key for the potential tenant. You have a security camera there. You have a Smart Thermostat to manage it. So again, it's a solution that doesn't necessarily tie into the security system. It's kind of a stand-alone unattended access solution. And then also within the Other segment, we have EnergyHub, which has actually been doing very well, provides a demand response system for utility companies. So what they do is they provide for the utility companies -- offer to their subscribers the ability to manage their energy usage. And what happens for utilities is if utilities have to go out and buy some energy out of the open market, it's very expensive. So it's a win-win for the utility and the consumer, the end subscriber. What the utility does is typically will subsidize a Smart Thermostat for the end homeowner and the homeowner agrees to allow the utilities to adjust their temperature, that might just be 1 or 2 degrees, but across millions of properties, that makes a big difference for the utility. EnergyHub charges the utility a per subscriber fee for that service. And so that's been doing very well. We've been signing up a lot of utilities for EnergyHub. And when you look at the overall Alarm.com revenue profile, about 6.5% to 7% of our revenue comes from the Other segment, but it's been growing at about 50%. So it's been generating nice growth.

And maybe we can drill into that a little bit because I think it's really interesting, like particularly initially, kind of the distribution model that you have. So what are the unit economics to Alarm.com versus the installers that you have, the distributors? And what is the value proposition, I guess, for the consumer or the business? Or -- like how does that revenue model flow back to economics for Alarm.com as well as the distributor and the value proposition for the end user?

In fact, we call -- it's not really a distributor, we call them service providers or independent dealers. So the way the economics work is -- and there's residential and then there's commercial. So it's a little bit different. Let me start with the residential. Let me step back a little bit and talk about kind of the market overall. So North America, there's about 120 million homes and about 24 million to 25 million of those homes have professionally installed security systems. About 8 million of them have interactive security, and all of our solution is interactive, meaning that you can interact with your security system outside of the home with your smart device. A year ago -- we typically announce once a year the number of subscribers we have. A year ago, we had about 6 million, now it is 8 million subscribers. And so the way we go to market really is through these dealers. We have over 8,000 dealers. And the way the economics work is that we actually charge the dealer on a monthly subscription fee based upon the actual end subscribers set up and solutions. So the average ARPU that we charge a dealer for the subscriber is in the mid to upper $5 range. The dealer typically charges the homeowner anywhere from $45 to $55 per month, depending upon the solution. And what's happened over the last couple of years is that we've added more features. And if you look at what Alarm.com does, what we focus on and why our ecosystem is so valuable is we're able to focus on the technology, to continue to provide better technology for our dealers so that they're really leading the market and providing better solutions for the end subscriber. So whereas we charge the dealer mid-$5 range for the ARPU for residential and the dealer then is focused on customer acquisition. They're focused on marketing and selling, installing, servicing to the end subscriber. Now a lot of people will realize that the dealer is also using Alarm.com's software to operate their back end. So we have a cloud-based solution. So the data, the actual operating software is hosted by Alarm.com in our data centers, but also a lot of the back end dealer portal, what we call the dealer portal, is also hosted and managed by Alarm.com for the dealer. So there's a lot of stickiness and a lot of value-add that we provide the end dealer to be able to operate their system, to be able to see what kind of configuration the end subscriber has, to set up the end subscriber. And so what we do is we focus on adding new technology, new features. So for example, 1.5 years ago or a little bit less than 1.5 years ago, we came with video -- we came out with video analytics. What video analytics does, it makes the system a lot smarter. So if you, as a subscriber, have video cameras, you're getting a lot of alerts. But if you have video analytics, you can make your system much smarter, send you smart alerts. And so in many cases, it reduces the number of alerts from 30 to 7 alerts per day, and the system can detect people, animals and vehicles. You could set it up. One of my favorite use cases is setting it up to detect there's a deer in your backyard, and you can have the system turn on your sprinkler systems and your light, or you can set it up to tell you that your spouse came home at the time you're expecting. Because, again, the whole idea here is to make the system, first of all, very secure, but also make it very value add. So even when there isn't an alarm, which is most of the time there's not an alarm, there's a lot of value-add that you're getting out of the system to be able to detect what's happening in your property, what's happening around your property, to be able to be aware that you have your glass door open, to alert you to turn out -- to close your glass door, to see what's happening with -- around your neighborhood. So there's just a lot of value-added information there. And when you look at our financials and look at how, again, we focus, we spend a majority of our revenue in R&D, so about 23% or 24% of our revenues on R&D. But from a unit economics point of view, from the sales and marketing, we spend about 12% to 13% of revenue on sales and marketing because we're really focused on providing the best technology for our dealers who then can really go to market with the best solution, and then they're focused on really signing up subscribers. But one way I look at our unit economics is looking at -- if you look at the amount of sales and marketing we did prior year to how much additional SaaS we generate in the following year, that kind of give you an idea of the payback. And typically, that's been about 12 to 15 months payback, which is pretty favorable for SaaS economics. And then when you look at the retention rate, so our dollar retention rate has increased to about 94%, which is very good. So what that means from an LTV to CAC ratio is when we've looked at our LTV to CAC ratio, given the lifetime value of a subscriber and typical lifetime for 8 to 10 years, is usually when a subscriber signs up, they've moved into a home and they have -- or they have a home, we typically aren't moving, and so usually they sign up for a 3- to 5-year contract, many of them renew. And so the average lifetime again is 8 to 10 years. What that does for LTV to CAC ratio, it gives us a ratio that's quite high of around 4.5x to 5.5x LTV to CAC. So it's a very favorable unit economics given the relationship and the unique ecosystem we have with our dealers.

Right. And see -- you mentioned like how much you're spending on sales and marketing versus R&D, obviously, a very R&D heavy right spending profile. On the sales and marketing side, what are you spending on for sales and marketing? And whether it's commercial or residential, how do you drive traffic to customer acquisition for Alarm.com as opposed to maybe some of the peers? So from a dealer perspective, what are they doing to drive Alarm.com subscribers on to the platform?

Right, right. So the way we really focus -- this relationship, the ecosystem with the dealers is that we do some awareness of the professional installed market. So we'll do radio advertisements, but many of you probably haven't seen any TV advertisements of Alarm.com because we really don't do a lot of advertising in Alarm.com. We really rely on our dealers to do the advertising. Because, again, we're focused on the technology, providing them the best solution, hosting the best software for them to be able to sell to the end subscriber. And because of the fact that we've, over the years, have signed up a good portion of the dealers out there. We have about, again, 8,000 out of around the 15,000 in North America dealers. So we really rely upon the dealers to do the end subscriber acquisition, to do the marketing. And we have a broad range of dealers anywhere from very large dealers to very small dealers. And so they're typically going to market in their local area, either sponsoring baseball teams or doing marketing on TV. And a lot of times, they're going to market and advertising based upon their company name, not Alarm.com. So in many cases, we're kind of the intel inside, if you will. So you may not even realize that -- the subscriber may not realize that it's Alarm.com. So that's how the ecosystem works really well. And the reason they work so well is because we can focus on what we do well, which is R&D and technology, and the dealer can really focus on customer acquisition and not have to worry about all the technology, all the system capabilities that we provide, which is pretty extensive. And again, we host the data, we host the solution. And so the dealer can really focus on their value add.

Got it. And maybe could you tell us what the barriers to accelerated or decelerating growth are? What are the primary factors that have driven because you have pretty robust growth and pretty healthy margins relative to other SaaS vendors? But what do you use as levers to kind of accelerate either growth or profitability depending on whichever one you're focused on?