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

Good morning, everyone, and welcome to 48th Annual JPMorgan TMC Office. My name is Tim Carpenter. I'm the Managing Director with the technology investment banking group at JPMorgan. I'm excited to be joined today by Alarm.com's long time CFO, Steve Valenzuela. Steve, welcome, and thanks for being with us today.

Thanks, Tim. Thanks for having me. And certainly wish it was under different circumstances, but it's great to join you today and certainly hope the next year, we can meet in person.

Absolutely. Looking forward to that. So before we jump in, for those that are not as familiar, please first just take us through the quick history of the company, a little bit about your unique go-to-market model, maybe a little bit about the core market and your competitive position in that market?

Sure. Yes. Thanks, Tim. So before I begin, investors, I just want to let you know that you can see our investor deck on the Investors section of our website. We've got a couple of good video testimonials on there as well. Their overview, and then also, very importantly, too, is our safe harbor. So I got to say that I would ask the investors to look at our safe harbor and this fireside chat is subject to our safe harbor as well. So with that out of the way, I'm happy to give you an overview of Alarm.com. I'm excited to be able to share with you the history of Alarm.com, and given the time, I'll make it a little bit short here. But Steve Trundle founded the company back in 2000 when he was CTO of MicroStrategy, and he was actually getting an alarm system installed by ADT, and he asked the installer what happens if somebody cuts this wire you're putting up? And the answer was, you'd have no alarm system. So alarm bells rang off, no pun intended, with Steve, being a technologist, but also realizing there's a lot of value in the data, even when the alarm is not activated. So make a long story short, Steve incubated Alarm.com within MicroStrategy from 2000 to 2008, spun out of MicroStrategy in 2008. And then they really tried at DIY. They tried shipping systems out of their offices, and it was just a very, very long process. And Steve and the team really hit on the idea that there's all these alarm dealers out there, service providers that we call them, that are installing plain old legacy alarm systems. And so the inventions that Alarm.com came up with, first of all, that makes the alarm system cellular base with the cellular backup. So that if your phone line goes down, your alarm system still works, but then even more importantly, is to make the system interactive. So you can actually interact with your alarm systems outside of your home. Prior to Alarm.com, that feature was not available. So you would go home and punch in the keypad, in the classic old alarm system, you couldn't interact with your alarm system outside of the home. And so that was the key invention that the team came up with. And right around 2008, 2009, if you recall, Apple came out with the iPhone and the App Store. Alarm.com's app was one of the first apps in the App Store. So that was actually very good timing. And so the team continue to make improvements on that. Our system is all interactive, meaning you can interact with your alarm system outside of your home and many other features. So continuing with the time line from 2008 to about 2001, the team started signing up all these service providers. Took about 4 years. Then in about 2002, we got to 1 million subscribers. So we really had to hit that inflection point, 1 million subscribers. And then in 2014, we got to 2 million subscribers. And again, having that dealer inflection point, having a certain number of dealers really got us that capability to be able to ramp up quickly. And then by 2015, we went public with about 4,000 service providers -- 4,000 subscribers. And today, we have about 6.8 million subscribers and over 9,000 service providers. And these service providers are independent businesses. So they're independent businesses in terms of being large dealers like our largest is ADT and also being regional dealers and also very small businesses as well. So we go to market through these service providers, the dealers, independent businesses. And the value proposition we provide is we provide the operating system for the smart home. So we provide the software, the technology, we host the services for the dealer. The dealer does the marketing, the servicing, the installation, the renewals, the customer support. When alarm goes off, it's the dealer's call center that actually responds to the alarm system. And so that's really the value proposition we provide. Again, we have about 6.8 million subscribers today and over 9,000 service providers, and we're a global company with operations internationally. Last year, international was about 3% of revenue. We think there's a big opportunity, international. So that's probably a fairly good starting point for the overview.

Great. Thank you, Steve. So let's jump into the topic of the day. So how has Alarm.com and its dealers fair during the pandemic so far?

Yes. It's been pretty incredible how quickly this pandemic has come upon us, right? And then we reported last Thursday our Q1 results, and we had record results. What we saw is we had a continuation of the growth we achieved in 2019 into January and February. Beginning of March, when shelter-in-place occurred, we did start to see a slowdown in terms of new activations, gross adds. We said on the call last week that at the low point, we got to about 70% of pre-COVID installations.The good news is retention has remained where it is. So our subscribers are still keeping their systems. And what we've seen recently is actually an improvement off of that 70% gross adds in the last couple of weeks, and it kind of coincides with the releasing of the number of regions releasing the shelter-in-place. And so we've actually improved quite a bit off of that low point, if you will, of 70% gross adds. And our deals are quite resilient. It's -- I'm really impressed. We got a daily update from our sales team from different dealers of what they're seeing. Clearly, some dealers, their employees did not want to go into homes. Some customers didn't want anybody coming to their homes. But our dealers have really, for the most part, figured out how to do remote -- have worked with the subscribers to do remote upgrades to video cameras, how to be able to make sure that if they're going to the home, they obviously do a call with the subscriber ahead of time, making sure no one is sick. The dealers have been able to get some PPE equipment for the technicians. And so it's kind of been all over the board. But when you have 9,000 service providers, and most of these are independent businesses, they figure out how to get things done. And so again, I've been very impressed with how resilient they've been in a challenging environment. And so it's encouraging to see the uptick in the gross adds in the last couple of weeks. And I think it really does coincide with the releasing of some of the economies, in some of the geographies, if you will, with the shelter-in-place.

That's great. That's great. And how should we think about any issues on the supply chain in terms of sourcing on hardware solutions? And how should we think about Alarm.com from the perspective of hiring and the impact of the pandemic there?

Yes. So in Q1, we actually had record hardware revenue. Over 65% of our hardware revenue is tied to video cameras. And so we actually have a very good supply chain process where we try to have at least 2 months of inventory on hand and a month on the water. Some of our finished goods do come from China. We did anticipate beginning of January and February with China really going through the COVID that there might be some supply disruptions. And so we did buy ahead, and we actually reported about 85% year-over-year recent hardware revenue, which was phenomenal, quite over expectations. Now we did say on the call last Thursday that we do expect hardware revenue to come down significantly in the second quarter, again, as things started to take hold in March with COVID, we have seen a slowdown there. And we do think that perhaps part of Q1's hardware revenue was some pull forward from dealers as well as stocking up in advance. But we've been fortunate that, for the most part, our supply chain has been considered an essential service and has been continued to operate, maybe not at the full capacity as prior to pre-COVID, but we do have some finished goods locations and assembly -- finished assembly locations in the U.S., and they've continued to operate. So we've been quite fortunate that we've not seen a large disruption in our supply chain.

Great. Great. And on the hiring front, how do you think about that? Are you...

Yes. Yes, that's actually a good point. We've actually -- we are very much an R&D company. We're really focused on software development technology. We spend almost 25% of our revenue in R&D. That's really the value-add we provide our service providers, our dealers that we want them to have the best technology available and always be at the state of the art. And so we've actually continued our hiring for R&D, and we've actually been able to hire positions, key engineering positions that we weren't able to fill pre-COVID as employees have become available. We've continued with our intern program. We have over 40 interns starting. We're going to start them initially virtually. So we've not slowed down on hiring at all. As a matter of fact, we've probably accelerated from what we were initially thinking for R&D. Now we have slowed down on -- in G&A, of course. Sales, we're still hiring sales for OpenEye in Spokane, Washington, the acquisition we did in the fourth quarter. They have a number of newbie sales positions. We think there's a big opportunity there. But we've been very fortunate to actually be quite successful in our hiring program.

That's great. That's great. So maybe we move on to financial performance. So one of the most attractive things about this business has always been its high-quality SaaS revenue. So talk to me a little bit about some of the key attributes around that revenue in terms of margin, retention rates, lifetime value, et cetera?

Yes. So we're very much a SaaS business, and the hardware really just enables the SaaS. So we price our hardware at around the 20% margin really to drive SaaS. Our goal always is to drive that recurring revenue. About 70 to -- 65% to 70% of our revenue is SaaS, it's recurring. It's about an 86.5% gross margin. As a matter of fact, last quarter, the gross margin ticked up 200 basis points as we've been able to get some efficiencies in our operations. So 86% to 86.5% gross margin for SaaS, highly recurring, highly predictable. As a matter of fact, we were able to give guidance for Q2 and for the year based upon the fact that we already have a lot of our revenue, if you will, essentially recurring coming in on a SaaS basis because we know what subscribers we added, like the subscribers we added at the end of last year really contribute to revenue this year. And so we have a very predictable model from that perspective. And the fact that retention rates actually -- retention rates have been between 92% and 94% in the past. This last quarter, they were 93%, which was only about 20 basis points lower than the prior quarter, which was more of a rounding error, but we've continued to see very good retention levels in our business. And I think the security -- the need for security is a fundamental need for people. They want to be safe. Businesses want to be safe, even when they're not at their business, they want to make sure their properties are secured. So we've continued to see very good retention and really not seeing any significant churn whatsoever.

Yes. That's great. So you brought up the topic of guidance. I thought it was interesting, you held out to your full year and your quarterly guidance. A lot of your peers have been pulling guidance, you're one of the few companies that has -- it's a pure cloud business, but has an on-premise implementation aspect to it. Help me think through kind of what went into that decision? And how do you think about guidance? You talked a little bit about the visibility. I'd love to hear more about that.

Yes. I think we had quite a big discussion on this, as you can imagine, with the Board too as to should we give guidance? Shouldn't we -- from our perspective, we think it would have been disingenuous to our investors to take it, quite honestly, to say we have a predictable model, which we do, highly recurring model and then not give guidance. It could have been an easy thing to do, honestly, everybody -- not everybody, but a lot of companies are not giving guidance. Now I'm not sure the recurring revenue companies, I think a number of them are giving guidance. I think it's fairly balanced. But based upon what we saw and we model, we modeled conservatism in our model. We factored in, obviously, some improvement off of that 70% low point we saw in terms of gross adds in March. And we felt comfortable with that given the last few weeks' uptick that we've seen. Now hopefully, that continues. So far, it still continues to tick up. I will say that if there is a second in a wave, if you will, in the fall, then you can't predict that. So we did caveat our guidance to say, look, this is what we see today. We are expecting that by the year-end, we'll be at about 95% of normal activations. But the thing about the model, when you have a recurring business model like ours, it's a very predictable, very recurring. So it's really hard to move the needle one way or the other to change it too much because a lot of what we're going to achieve this year, we've already added those subscribers in the first quarter and last year. So it's really predictable as long as we continue to maintain that retention, which we have so far. But yes, it was a very, very important discussion. Again, we could have taken the guidance off. And in fact, we guided SaaS for the year at 99% of our pre-COVID guide. We feel good about that.

And maybe talk a little bit about, in this environment, cash collection. So what have you seen? What do you expect to see in terms of any changes on the cash collection and cash flow side?

Yes. So we have a range of dealers anywhere from small dealers to, again, ADT. And so we have tried to be flexible, allow a little bit extra time for the dealers. We want to help them in this difficult time. And so in some cases, we've given them -- we've not pushed, if you will, we haven't done a broad program, but our DSOs in Q1 were 49 days, flat to Q4. So they're same DSO levels. Now I will say in Q2, they'll probably tick up a little bit. But we watch our receivables very closely. As a matter of fact, over 90% of our receivables, even recently, are current or within 30 days. And so we've been getting a little bit more grace period for our dealers to pay. Most dealers have also been paying on time. And a number of our smaller dealers actually have taken advantage of the PPE -- PPP, I should say, and been able to actually get some government funding, which has been helpful in terms of being able to maintain their employees. And so that's been helpful as well. But we watch receivables carefully. We have a good cash flow generation business, good cash flow model. And so we feel very good about our very strong balance sheet, very good collection history, DSOs.

Yes. That's great. Now I believe you reported that you pulled down $50 million on the revolver?

That's right.

We've seen a lot of that cross-checked. Help me understand, is that kind of conservatism or safety? Obviously, you're cash flow positive model. Or is that kind of a function of what you're talking about before in terms of helping out the dealers on kind of timing?

Yes. It's really -- we did that at the -- right at kind of the beginning of the COVID shutdown and we talked to our banking syndicate. And the feedback from them was like look, you guys don't need this, but everybody else, some of the other clients are pulling down their revolvers. So in the -- and we talked to the Board, and we decided there's going to be. Fortunately, we have a good cash flow business, we're probably going to generate $40 million to $50 million of free cash flow this year, but there's going to be probably some opportunities here to really do some M&A at some point, possibly, if the right opportunities come along. And so it was a combination of realizing that we didn't know what was going to happen with liquidity. We want to be able to pull that down. The cost was very low. As you know, interest rates are very low right now. And so -- and the term is on that revolver, it doesn't expire until October 2022. So we felt it was the right thing to do to put it on the balance sheet and we think that we have the opportunity, given our strong balance sheet and our cash flow generation, to emerge out of this an even stronger company with some good, perhaps tuck-in M&A opportunities. We don't necessarily have anything planned right now but we're watching carefully. We're going to be very careful. We have done a few acquisitions. As a matter of fact, last quarter in Q1, we announced that we spent about $4.4 million on a couple of small acquisitions. And last year, we acquired OpenEye, where we spent about a little bit more than $60 million, all cash. And so we felt that for our investors, we've only done an IPO, we've not done a convert. We've not done a secondary, so we felt putting the additional debt, which is, quite honestly, right now, we're a little bit more than 1x EBITDA, which is fairly low debt ratio. I would say, very low. And so we felt that, that was a way to have some extra optionality, if you will, without diluting the investors.

Yes. So I want to come back to the OpenEye and Doorport topics. But before we do that, you've initiated for the first time a share buyback. Talk to me a little bit about thoughts around that buyback and what your plans are in the future as it pertains to that buyback.

Yes, exactly. And the timing of that also was around the timing of when we pulled down the $50 million. So there is a possibility. We -- at the right point, we may continue to do more buybacks. The Board authorized a $75 million share buyback in about November of 2018. So the program currently goes through November of 2020. And so we put that in place if there was going to be some out-of-normal situation occur. We obviously didn't know at that point in time that what was going to happen with COVID. So we actually activated that given the strange activity we saw occurring in the stock during COVID and felt that the levels got really too low. And so we'll keep that optionality available to us. And like I said, we spent about $5 million of the $75 million authorized. So we still have about $70 million available. Not saying we're going to necessarily use it, but it's there. And we'll see how things progress.

Great. So maybe we'll shift the topic to video. So we talked about video before, explosive growth that you've seen in that segment. And for obvious reasons, because I think we can all relate to that. It's been a key initiative for the better part of the year now. Your hardware sales have been significantly up, which you've attributed again to the video -- the sale of the video cameras. Talk to us a little bit about the software analytics platform that sits behind that, right, because there's obviously a hardware aspect to that. But the value prop is very tied to the software that you've built around it. So talk to us a little bit about that and specifically the economic side as well.

Yes. No, that's a good point. So we acquired ObjectVideo in January, actually in 2017, a team in Reston, Virginia here, not too far from our headquarters and brought the team onboard. They were doing a lot of work for the government. As a matter of fact, on the investor deck, there's one of the key engineers there who talks about ObjectVideo. But they were doing a lot of networking AI for the government. And so we repurposed them for video because we really feel that having a video system that is intelligent and provide a lot of value add. And so we've actually complemented that with a lot more software engineers and key even video analytics. And so about a little bit more than a year ago, we released our AR video analytics platform that really allows the subscriber to be able to have smart alerts. And we've heard from subscribers that their alerts per day have gone from like 60 -- 50 to 60 alerts per day down to 7 or 5 or 7. And so it's made the system a lot smarter. The system can recognize people, places -- people, animals and vehicles. And so my key -- my favorite feature is to be able to have your sprinkler systems and lights turn on in your backyard when there's an animal in your backyard. There's a lot of other good features for commercial, too. So you can -- commercial business can use that to detect if there's somebody loitering in the backyard -- I'm sorry, in the back of their establishment to be able to do -- eventually be able to do line counting, to be able to tell if they send -- need to send more employees to one of their other restaurants, if you will, in the area, if they have a longer wait there. So there's a lot of capability with video analytics, and we're still at the very beginning. But what we've seen is a pretty significant uptick in video analytic adoption. And the way the financials work, the metrics, is that typically the ARPU that we charge the dealer and we've talked about it as an average -- in the average of $5.50. If you have video, then we're probably charging the dealer, on average, closer to $6. And then video analytics, we charge the dealer additional $0.80 to $1. And then, of course, the dealer charges -- this is per month. This is the ARPU. Then the dealer, of course, charges the subscriber, either the residential customer anywhere from, let's say, $40 per month to $55 to $60 per month depending upon the system. For commercial, the ARPU we charge the dealer is about $10 or more depending upon the system. And then they're able to charge the commercial business closer to $100. So it adds a lot of capability for the service providers to be able to add more value to the end subscriber, for the service provider to make a higher revenue, and even as importantly, it really drives retention. Because the value-add you get from your system of being able to check in and get smart alerts. And if you have a system with a lot of video, it can be kind of overwhelming if you don't have smart alerts because you get a lot of alerts. And so it really provides a capability that is -- that drives a lot of retention, drives a lot of value-add to the end subscribers. So we're just at the beginning. We think there's a lot of capability in video analytics in recognition, both for residential and for commercial customers.

Yes. So let's dive a little deeper on that. So help us understand how should we think about penetration of, I guess, number one, video within your installed base, but then, number two, software analytics within the video install base, the camera install base?

Yes. So last time we updated this, we said, in a typical quarter, more than 35% of those new subscribers have video. Of those, about 40% to 50% up for video analytics. So that's new subscribers in a quarter. Now we don't update it every quarter. I think that was the last time was Q4. We're probably doing a little bit better than that in Q1. But also what's interesting, too, is existing subscribers, on average in a quarter, existing subscribers account for 15% to 20% of our camera sales. So they're upgrading their systems in a quarter. Overall, if you look at overall of our 6.8 million subscribers, less than 20% of them have video today of the overall population. So there's still a lot of upside in terms of penetration to the subscriber base.

Got it. Great. Okay. So next topic I want to cover today here is your commercial business. So maybe to start off, can you talk to us a little bit about kind of how should we think about the mix of the business between residential and commercial broadly?

Right. Yes. So we actually started Alarm.com for Business about 1.5 years ago. And today -- prior to that, there were some service providers providing the [ alarm ] systems to small businesses like a local Wendy's or insurance or local coffee shops. And so Alarm.com for Business was really started with the gear -- with goal of really providing unique features that a business requires such as auto alarming at night, sometimes employees will leave and they don't put on the alarm. So auto alarms for the business. But today, it's about -- less than 8% of our SaaS revenue comes from commercial. That's SaaS revenue, right? And so most of our revenue is still coming from residential customers. We did acquire OpenEye in the fourth quarter of 2019 last year. We said that their revenue is going to be about $40 million for 2020. Most of that is hardware revenue because in the -- prior to them being acquired, they were a private company, they were optimizing more cash upfront. And so they were selling their system, which is cloud-based, as a term license, if you will. And so we decided to count that revenue as hardware and other revenue. We've now worked with OpenEye to come out with a SaaS offering, where over time, we expect the SaaS revenue from OpenEye to increase. If you look at in Q4, they contributed about $100,000 to our SaaS revenue. In Q1 of 2020, they contributed about $200,000 of our SaaS revenue. So very small SaaS revenue today. For the year, we think their SaaS revenue contribution will be a little bit less than $1 million. But over the next few years, we do think that they'll start to contribute more to our SaaS revenue, given that we've actually repurposed, if you will, their offering and come out with versions that are -- that we can account as a SaaS operator.

Yes. So maybe double clicking on that a little bit. So help me understand kind of what those factors are that play into converting that revenue to SaaS? So how does that play out over time?

Yes. So the system has to be set up and has to be priced in a way so that it's counted as a subscription-based model versus the term license. So this will apply more to new deals. Now some existing customers will still want the term license. And so OpenEye is not going to necessarily go back and change those terms. But we need to be able to account for it on a SaaS basis as a subscription model instead of an upfront payment and upfront in a term license. So it needs to be a subscription, not a term license, as has been the legacy system that OpenEye has provided. Again, it's going to be a small number this year for SaaS, less than $1 million. But we think that there's opportunity going forward. And we're excited about the OpenEye opportunity. They provide us a great entry into the enterprise. So prior to OpenEye, the Alarm.com for Business was really geared towards small business, which is still a good market. 4 million to 5 million potential properties for small business, but OpenEye expands us into the enterprise and some of their customers are pretty well known names. Whataburger, Gonzaga University, there's other customers that have the theme parks we can't name that are big customers and franchisees. And so they sell into -- they had over 400 dealers, if you will -- integrators that sell into franchisors and sell into large restaurant chains and such. And so we think there's a good opportunity there. And there's only about a 15% overlap between our dealers, Alarm.com dealers and OpenEye dealers. So a complement to the business.

So the OpenEye deal is interesting because, as you referenced before, you are undoubtedly a R&D first organization. You have not been active in M&A historically. What is it that -- you talked about the business a little bit, but kind of help us through the thinking of what caused you to, number one, build versus buy, and number two, kind of get comfortable with an acquisition. I'd love to understand a little bit about just kind of what you found subsequent to buying the business, how that impacts how you think about M&A going forward.

Yes. First of all, one of the key features of -- key things we look at is cultural fit and make sure the management team is consistent with our focus on customer support. We really focus on making sure we're providing our dealers the best customer support. OpenEye was actually not for sale. They had been privately funded, self-funded. Rick Sheppard, the founder and CEO of the company, has been running the company from the beginning, not taking any VC money, and they were looking to raise some money. And so we heard about them and we actually approached them. What we found was a company that had, quite honestly, not invested as much because they didn't have the -- they were, again, self-funded. And so we saw an opportunity here where their cultural aspect, their focus on customer service complemented and very much consistent with our approach to the business. Again, we talked to some of our dealers, they had a very good reputation in the marketplace. And so we really see -- saw an opportunity here. We're bringing OpenEye on board. What OpenEye and Rick Shepherd and the team saw was an opportunity to accelerate their business. So instead of thinking of it as selling out, they were thinking of it as joining up. And so Rick really sees the opportunity to accelerate his business being part of Alarm.com. And I'm happy to say that we've retained Rick and all the management team of OpenEye as part of Alarm.com and kind of the way Steve Trundle founded the company, incubating with the MicroStrategy. Steve applies that to businesses we acquire. So that Rick still has -- they still have the OpenEye name, they still have their own identity, they have their own sales teams. But they leverage our R&D expertise, they leverage our G&A infrastructure, our cash, of course. And so it's really a great way to effectively still run a small business, if you will, within a larger company. And so we've applied that to OpenEye just like we did with EnergyHub and PointCentral, the other businesses we've acquired over the years.

Yes. And help us understand a little bit just the pace of integration and where you are on OpenEye and Doorport in terms of integration, and how should we think about impact, I guess, particularly on OpenEye to margin contribution going forward.

Yes. So we actually -- from a G&A point of view, we've integrated OpenEye. So we've taken over the payroll. We've taken over -- we've added into our HR system. And -- but for the most part, they're going to do their own selling or the R&D team is already working with OpenEye R&D team at Alarm.com in terms of analytics, bringing -- which we think, by the way, is a big opportunity of being able to take our analytics engine and incorporate that into OpenEye solution. So the R&D teams are working together. But again, we kind of do a soft, if you will, integration. We want them to still have their own identity. We want them to benefit from the back end of Alarm.com, but be able to still be nimble and be quick and move fast. From a margin perspective, they actually help our gross margin a bit. Their gross margin of hardware is closer to around 25%. And so this last quarter, our gross margin overall was around 23%, whereas a year ago, it was around -- between 18% and 20%. So their gross margin is a little bit higher than our gross margin on hardware. And then of course, as they add more SaaS, their SaaS margins are equivalent to our SaaS margins.

Great, great, great. Well, we've got about 30 seconds left and they're keeping us to a tight schedule here. But I guess, Steve, maybe last question here is international. I'd love just to understand kind of total opportunity and recent trends in the international business, what should we expect there?

Yes. So that's a good point. We signed a number of new dealers last year internationally that have existing legacy subscribers that they'll be adding this year, which we think was going to contribute to growth. Now I will say that we did see more of a shutdown internationally. So internationally saw more of a decline, but that has started to come back as well. But there's probably more of an impact from the shutdown internationally. We still think international can be 20% to 30% of our revenue in the future over the long term.

That's great. Well, our time is up, Steve. I appreciate you joining us today. As always, it's a pleasure. Congratulations on your continued success, and talk to you soon.

Thanks for having us. Thanks very much. Have a good day.

Thank you.