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

Hi, everybody. This is Nikolay Beliov, software analyst at Bank of America. We're happy to have today with us Steve Valenzuela, the Chief Financial Officer of Alarm.com. Thank you, Steve, for joining our conference.

Thanks, Nikolay. Great to be on. And as we were talking, hopefully, next year, we can do this safely in person in San Francisco, sunny San Francisco.

That will be fantastic. That will be fantastic. Let's just jump right in. To start off the conversation, how has COVID impacted your business? What are you seeing as durable trends coming out of COVID? And what is your best assessment of how that might impact your business and business model in the long term?

Nikolay, that's certainly the question of the hour and the months, certainly the focus. Before I begin, I did want to mention that investors can go to the Investors section of our website. We actually have a very detailed investor deck there that provides a lot of information we can't cover in the next 30 minutes. It also includes our safe harbor statement on Page 2, which I will have to say that this discussion is subject to that safe harbor. So going back to your question on COVID, certainly, that is a key point of discussion. We talked about on our Q1 earnings call on May 7, that at the low point in March, gross adds were running at about 70% of pre-COVID. And prior to that, in January, February and last year, we were seeing a good amount of gross subscriber adds. The good news is, and as we said on the call, is we've seen a recovery from that, from the 70% of gross adds, pretty much tied to the opening of the states and the geographies, the relaxing of the shelter in place. And what we did [indiscernible] for the year is that we've guided -- factored in basically that we expect to be at about 95% of pre-COVID gross adds by the fourth quarter. Now I have to caution that, that assumes that there's not a second wave and another second wave of shutdown, which we can't predict or plan for that. But I would say the good news is that our retention has been rock solid. No difference between post-COVID to pre-COVID. So -- and that kind of makes sense because in a time of uncertainty, people need more security, they need to be assured. And so the need is even greater, I would say, but we're -- I think we're very encouraged. We go-to-market through over 9,000 dealers, who we call service providers. These are independent businesses, ADT being the largest. And they've really done a great job of adapting to the situation and making sure they provide their employees proper protection, making sure they take precautions going into homes and businesses. And so well, obviously this is a very serious situation with COVID, first and foremost, we want our service providers and their technicians to be safe. And -- but they've really done a great job of working around the situation. Some dealers were shut down for a period of time. Other dealers, really, continued to operate pretty much at 100%. And so it really depended upon the location. I would say one thing that I think is probably helpful is that when you think about Alarm.com, it's really geared, at least the residential business, really geared for homeowners. And so in some of the larger cities where you have a lot of concentration of people like New York City, for example, we actually haven't had a lot of business there because that's mostly apartments. And so I think given the way that the dealers have responded, I think the -- our business had been very resilient compared to a number of other businesses. And as I mentioned, we've continued to see a good recovery from that low point of 70% of gross installs. I think Europe was actually a little bit worse than that in terms of the shutdown was more severe for a number of months, but they've come back as well. So I think all in all, we're quite encouraged with the resiliency of our service providers and of our business model.

And Steve, can you please comment on the long-term impact of COVID on your business? For example, if you can touch on would you envision the industry would steer towards more remote installation, et cetera, et cetera. What do you see is the durable impacts coming out of COVID on your business and the business model for your service providers?

Yes. We haven't really seen much of that. There has certainly been some dealers who have taken this time to provide upgraded cameras to subscribers and mail them out and then talk them through actually installing those. But I think the dealers, again, have been able to make sure that their -- take precautions going into homes or businesses make sure that the homeowner or the business person is not nearing around the technician and then providing the protection equipment to the technician. I do think that, if anything, in a time, typically of uncertainty, security is more important. And typically, what we've seen in past, let's say, recessions, my understanding is security has done quite well. I do think that there is a lot of resiliency in this model. People need security. People need the capabilities that you have with a smart property. One thing that's interesting, too, is for businesses, we've actually seen some dealers actually have seen an uptick in business from small businesses. As you can imagine, some of them have security, but they don't have the interactive security cameras as much that they can use outside of the business. And with the businesses sometimes shut down, they've actually seen an uptick in some areas. Anecdotal information indicates that businesses are taking this time to upgrade their security system, so they can monitor what's happening in their business when they're not at the establishment. And so we think that's been part of the -- helpful part of the business model that's complemented the gross add, subscriber add coming back up from that low level we talked about.

On that note, let's talk about the commercial offering. Could this be a potential significant business driver for the business? And as businesses reevaluate their real estate strategies with COVID and post-COVID, what are the threats and opportunities in your mind here?

Yes, so our commercial offering is not really geared toward like commercial properties in terms of the -- like office buildings. It's really geared toward commercial businesses. And so we started Alarm.com for Business in about April of 2018 and really geared towards small businesses, coffee shops, restaurants, insurance agencies. Small businesses, you might have a business owner or it might be a Wendy's franchisee who might have 5 different locations or 8 different locations. And so we think the need for the interactive solution is even more important today because if you think about a business owner, they've got to manage what's happening at their establishments in multi -- in different locations. And being able to see on the cameras, what businesses are having a longer wait time, to be able to use our video analytics capability to see what's happening around their property, make sure nobody is leering in the back of their establishment from a security point of view. And there's a lot of features that come with Alarm.com for Business that's different than the residential. For example, auto alarming. A lot of employees sometimes forget to alarm at nighttime when they close the store. And the commercial business auto alarms if that's -- if the employee has not turned on the alarm system. And then we're using our AI capability to provide more and more capabilities for the business owners. So we think that there is a lot of opportunity. And when you think about commercial, it's probably less than 8% of our SaaS revenue today. So there's quite a bit of opportunity and when you think about OpenEye, for example, that we acquired in October last year, that expands our solution from small business into the enterprise. And what OpenEye does is provides a commercial cloud-based security system with recorders and typically many more cameras than the small business offering we have, to large integrators who put those into large establishments and nationwide franchisors. Some customers we can talk about are like Olive Garden, Bed Bath & Beyond and a number of other like theme parks, which we can't name, nationwide restaurants, franchisors. And so this geared toward larger install -- installations. And also including universities are also customers and high schools or such. So I think obviously the world is not getting any safer, so I think OpenEye solution is even more relevant today than it's been in the past couple of years, given the need for security to monitoring what's happening around the multiple different locations. So we're excited about the opportunity with OpenEye.

And Steve, you mentioned you work with 9,000 service providers. How many of those also book commercial? And where are you in terms of channel adoption, service provider adoption of the commercial offering today?

Yes, that's a good point. One way to look at this is to distinguish too. So with OpenEye, which we acquired, right, recently in October, they had a little over 400, what we call, service providers. A little bit different than the Alarm.com 9,000 service providers. The 400-plus, there was only about a 15% overlap with Alarm.com dealers. So most of the OpenEye dealers are large integrators that sell into commercial businesses that might be selling commercial refrigeration systems, other kind of equipment, and they'll bring in OpenEye for the security system. For the Alarm.com 9,000 dealers, all of them really can do commercial. It's not that big of a difference really in terms of the implementation. What we've seen in the past 90 days or so, about 25% to 30% of the 9,000 service providers have implemented a commercial solution. One distinguishing factor is access control, which is a complementary solution to our Alarm.com for Business, which is really new. And that's the area where we need to train the dealers on how to implement access control because you have to put in effectively some hardware on the doors of the establishments, and we actually use it in our headquarters here in Virginia. So that's an area where we've been training the dealers over the last couple of years of how to implement that, how to be able to use it. And the idea being, with access control, is that it complements the Alarm.com for Business because the business owner can provide electronic access to their employees and quickly target, if you will, certain access times for various employees just using a computer screen. And the employee can use their smartphone to unlock a door. And so it's quite a big capability. But it is a new offering, relatively speaking. So that's an area where we've had to train the dealers, and that's kind of distinguishing between commercial and access control. There's been some confusion in the past about kind of combining those 2. And in fact, it's separate. Commercial, Alarm.com for Business is very well addressed by a lot of Alarm.com for dealers. It's just the access control that's the new offering that takes some training and learning how to set those up, how to implement those, how to set up the dashboards for the businesses to be able to provide access to their employees.

Got it. Got it. The acquisition of OpenEye increased the hardware contribution of the revenue mix by 10%. What's your view on, as a CFO, where the software versus hardware mix goes over time and in the long term?

Yes. Given that we really focused on the recurring SaaS revenue, the software, because the gross margins there are around 86% plus. And then the hardware gross margins are in the low 20% range. But we have, over the last couple of years, added a number of capabilities with our video and video analytics that really has driven a big increase in hardware. If you look at, for example, in Q1, hardware revenue was up, I think, over 80% year-over-year, and a lot of that was driven by video. And video is something where we really believe that we have to provide, at least today, the video cameras based upon the capabilities that you need the right kind of chip built into the camera to be able to take advantage of our video analytics system. So ideally, over time, we'd like to see hardware ideally less than 30%. But at the same time, video is complementing the adoption of the security system and the smart property. So it is kind of a good news situation where more video ultimately leads to more SaaS and a higher, we think, lifetime value because as subscribers can take advantage of the video analytics capability, they're using the system every day. They're seeing what's happening around their property every single day, so they get a lot of value add. So we're hopeful over the next few years that, that will actually translate even into a higher subscriber retention rate.

Got it. You mentioned that commercial is less than 8% of the business. Are you talking about commercial, residential, 8%?

8% of SaaS, sorry. 8% of SaaS.

8% of SaaS? And what was that number a year back?

That's a good question. I don't have that right off the bat. But I would say -- I would just say generally, commercial, hardware and software, has been running at a higher growth rate than residential. And let's say, on average, it's been growing at about 40% plus per year. So that'll give you some idea.

Okay. Okay. Got it. And where do you think the 8% goes over time?

Well, we think -- one of the things we're excited about with OpenEye as well is our video analytics engineers are working with the OpenEye engineers to adopt those capabilities in the solution for OpenEye. And you can imagine if you have, let's say, you have a franchisor or a university with 100 or 500 cameras, if you have a video analytics capability of monitoring those locations and having smart alerts that we think that will provide a lot of value add. So we think there's a lot of capability there for the capabilities for commercial. We haven't really set necessarily a target, but I think given the growth and given the opportunity and given the TAM, because you think about in North America alone, there's 4 million properties that we think that would qualify for very -- for our small business Alarm.com for Business. And then with OpenEye's cloud-based solution, the TAM that I've seen there is multiple billions. I think it's $4 billion TAM or something like that is the opportunity. So hopefully, over time, we think commercial can continue to increase as a percent of revenue and percent of SaaS.

Got it. Got it. Switching gears to the international opportunity. If you can give us an update there.

So international has really been seeing -- we've been seeing good growth there as we've added a number of new subscribers internationally through a number of dealers. We've expanded the economies that we've been able to enter into. So now we have, I think, over 40 countries that we're in internationally. And the way we've been doing that is very much similar to how we've addressed the North American market, is by signing up key dealers in various markets to be able to train them and then have them come up to speed on the Alarm.com solution. So it's a little bit more time-consuming internationally. You've got different standards you've got to meet. And then you've got different cellular partners you have to work with because our system, of course, is cellular-based. But international last year was about 3% of our revenue. And we signed up a number of new dealers who are converting some legacy systems to the interactive system. Now I will say that COVID certainly has slowed that down a bit. And so we have some delays with those new dealers actually rolling out because of the shelter in place, but it's just a matter of a delay, not a -- it's ultimately going to be implemented. Probably will be delayed until later next year or maybe -- later this year, I should say, or early next year. But international has been growing at a good clip. Again, it's only 3% of revenue. Given the TAM, we think that the opportunity internationally is as large as North America. So what we would hope is over a number of years, and we obviously haven't indicated how many, we don't really know for sure, but hopefully, over some period, international could represent 25% to 30% of our revenue.

Got it. Got it. Switching gears to service providers, which are your -- is a B2B business model, their customers at the end of the day. How would you evaluate and how do you monitor the health of the service providers?

So we have a range of service providers all the way from the largest, of course, being ADT, and then some smaller service providers. All of them are independent businesses. I would say that they've been, again, very resilient. Some of the smaller ones have been able to get the funding through the government, the PPP funding, which was good. And in fact, we connect and we have discussions with the service providers on a number of occasions and have close relationships with them to see how they're doing. We look at our receivables from the service providers on a regular basis. And if you look at our DSOs, for example, at the end of March for Q1, DSOs were 49 days, which were flat to DSOs as of December 49 days. So now Q2 will probably be a little bit higher because one thing we have done is we have informally given a little bit more grace period to our service providers to give them a little bit extra time to pay, maybe 15 days or so, just informally and not really press them. And so I think that's been helpful. But I would say that generally, the service providers are quite resilient because one thing to think about is that some of the service providers, if they need to raise cash, they can actually sell accounts because the accounts are considered annuities and there's a financial market for those accounts. So there are some dealers that actually buy accounts from other dealers. And so it builds a lot of resiliency into the business model. If a service provider does need to raise cash, they can sell the accounts at a multiple of RMR. They don't like to do that because they want to keep obviously those -- that recurring revenue. But it helps to backstop the service providers. And so to date, we certainly have not lost a service provider. We've seen them continue to -- some do better than others, of course. But overall, I would say that there's not been a major change with COVID compared to pre-COVID in terms of the service providers.

Just a reminder to the audience, you can ask a question anonymously in the chat box, so feel free. So Steve, switching gears to some of the numbers here. You mentioned in the beginning of the conversation, some of the assumptions underlying the 2020 revenue guide. But can you help us with some of the math here, if new business is down 30% in the near term, how can you mathematically grow subscription revenues in the 12% revenue guide range for 2020 that you gave?

By the way, Nikolay, that's my favorite question.

Okay. Great.

So the reason is because the beautiful thing about the recurring nature of the SaaS business is that a lot of our revenue this year is in SaaS. It's based upon the subscribers we added last year because of the -- if you think about the stairstep of the SaaS business grows on top of it. So for example, the SaaS subscribers we added in Q4 of last year only contributed, let's say, a few months of 2019, but they contribute all of 2012 (sic) [ 2020 ]. So you can't just say, "Well, if your business is down 30% gross adds, that means your SaaS is going to go down," for a couple of reasons. One, because of the way the stairstep of the SaaS reoccurs and you get the full benefit this year of the subscribers you added partially last year. And then second of all, we said that the business was down 30% at the low point. So that's a short period of time. And we've said we've guided based upon the recovery to the point where by Q4, we would be at 95% of gross adds compared to pre-COVID. But again, because of the nature of the SaaS business, it's highly predictable. Obviously, where the growth we've guided to is a little bit less than the guide pre-COVID, it's actually 99% for SaaS of the pre-COVID guide. And that's because of the SaaS model because of the recurring predictability of the model. Now that said, clearly, next year's SaaS will be slower growth than we would have otherwise had, had it not been due to the slowdown of COVID just because of the way the business -- the way the SaaS grows. I think given the guidance we provided this year of low teens, I still feel comfortable with the low teens SaaS growth going forward, even with the COVID slowdown. But that's the reason why it's the way the business model -- way the SaaS revenue stairsteps on top of the previous subscribers added.

Okay. Another interesting trend in the numbers we noticed this quarter in Q1 was the other -- it relates to the other segments, which is your energy business, your rental business, vacation rental business. So in Q1, that business, other SaaS business was down 2% year-over-year on what looks like tough comps, which means that the core SaaS business actually accelerated in Q1 to 15.9% versus 14.6% in Q4 after it bottomed out in 12.6% in Q3. So what is driving this reacceleration in the core SaaS business when you look at the other segment? And if you can just also talk about the seasonality of the Other segment, which was a headwind in Q1, should it expect to become a tailwind for the business for the remainder of the year?

Yes. So there was one thing that occurred in the Other segment in Q1. In Q1 of 2019, there was a new program that was signed up by EnergyHub for gas in California, which was a new innovator program. All of EnergyHub's has previously always been electrical. And I think what happened is that program did not get renewed by the regulators. The utility wanted to continue with that program, but they had to get approval by the regulators. And I think given what's happened in California with everything else, and as you can imagine, with PG&E and everything, I think their focus is on other areas. So that program, which was a 7-figure program a year ago, did not occur -- reoccur in Q1 and likely won't reoccur. So that was a headwind, if you will, in Q1, but we don't -- at this point, we don't see any other headwinds. And in fact, we think based upon the utilities that EnergyHub have signed up, we think it will be a tailwind going forward. There is some seasonality that occurs with EnergyHub into Q4. Typically, we get the benefit of the energy savings in the summer months that contribute to the Q4 number, but that's really the only seasonality for the Other segment business from that perspective. And I think that answers -- was there another part of your question?

Yes. The other part was when you adjust for that, the core SaaS business accelerating, other SaaS has been reaccelerating after bottoming in Q3 last year. So what is going on under the covers here?

Yes. So a combination of things. Again, it's the subscribers that we added last year that we got the full benefit of this year. And last year, we did have some, let's say, some hiccups, if you will. From time to time on the SaaS revenue, we weren't able to recognize all the SaaS revenue in Q1, and we've kind of worked through that. And so the main thing was that we've been expanding commercial and international and we're starting to get the contribution of those subscribers into our SaaS revenue. That's really the main reason. With the investments we've been making in commercial, international and then also video analytics because, as you know, video analytics increases the ARPU that we're able to charge the dealer and the dealer is able to charge the subscriber. So it's really mainly the addition of new subscribers across the company both in commercial and in residential, international that's really contributed to that. And again, it's -- the way the stairstep works with SaaS, you don't get the full benefit right away, right? Because the subscribers you had in the quarter, you only have maybe half of -- 1.5 months of the full effect of that. But then the following year, you get the full effect. So that's the way the model works.

Got it. Got it. So we touched on a few of the growth drivers of the business, just to maybe help us put it all together, Steve, can you stack rank them going forward in terms of impact to the numbers? International, commercial, other SaaS, et cetera, et cetera. You mentioned the 40% growth in commercial. Just maybe help us stack rank them and put all these growth levers in context in relation to each other.

Yes, I like this question, too, because it's kind of like which child do you like the best? I love all my children. But no, it's a great question because there are a number of good growth drivers here. And it's hard to say which one is stack ranked over the other because of the investments we've made in international, commercial, both are growing at good clips. Video analytics, I would say, is also a very good growth driver because of the capability it provides in terms of the end subscriber being able to get value-added information every day and value-added alerts every day and what's happening with their system. But I would say all of those are really good growth drivers. And just generally, the way the company is focused on providing technology to expand the use of the smart system, with security being the hub of the smart property, we really think over the next 10 years, that every property should be a and could be a smart property, either commercial or residential. And we think that we have the opportunity, given our technology, with our dealer base to be able to be the leader in that area. And we think security is a great platform to build off the smart properties. So we're continuing to invest in new technologies and in fact, even during this period of COVID time, we've been quite successful in hiring a number of key engineers, and we continue to hire engineers. I would say we're not at the level we planned for the year given the limitations of hiring, but we've continued with our intern program. We have all our interns starting, actually just started. We have a number of key engineers we've hired. And so we're continuing to invest. There's a lot of interesting technologies that we're continuing to work on that we think will make the system even much easier for the end subscriber to use, better technology for the dealer because, again, the dealers use our technology in much of their back end to be able to manage their business in terms of what's happening with the installations, being able to easily do remote diagnostics. So there's a lot of tools we provide the dealers as well. So it's really the focus on technology innovations to make the system much more capable.

We have time for one more question. And I would like you to talk about your view on the competitive landscape. What are you seeing out of the cable providers? What are you seeing out of DIY? It seems like the DIY wave has quieted down a little bit, but I just wanted to get your perspective on different aspects of the competitive landscape.

Yes. So we definitely have a number of competitors. And internationally, it's different than it is in North America. I would say the historical competitor has been Honeywell. They're really the legacy provider, mainly of the hardware and of the legacy landline security systems. Honeywell spun out Resideo. And so that's, I would say, really our key competitor now. There are some smaller competitors that have just maybe 100,000 or so subscribers or less. Those are private companies that I'm not going to name but then there are -- you could say there are indirect competitors for our dealers, although these tend to be more point solutions, what you call, for DIY where somebody might want to put in a thermostat, they might want to put in a camera. Obviously, there are some DIY providers out there that have been advertising like crazy. I think what we've seen is it's a different consumer, different use case. If you have an apartment, if you're not that worried about security, then you might want to put in the DIY system. But if you have a vacation property, you have your home, you want to be able to use your system. You want to make sure it's going to work every time because we really go to market, first and foremost, focused on safety and security. And then we add on top of that all these smart home features. So our go-to-market is very much different than the DIY, which is more about simplicity and point solutions, I would say. And for some apartment owners and stuff, it's a fine solution.

Got it. Steve, any closing remarks on your end before we wrap it up?

No. I would just say, really appreciate the time, and thanks to everybody on the call for taking time today and your interest in Alarm.com. And Nikolay, like as we talked about at the beginning, I really hope next year, we can do this safely in person in San Francisco.

Yes, I look forward to that Steve. And everybody, please stay safe and healthy. Thank you, everybody.

Thank you.

This concludes our presentation with Alarm.com. Thank you.