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

Okay. Hey, good morning, everyone, and welcome to Day 2 of the Barclays TMT conference. My name is Saket Kalia. I cover software here at Barclays. Very happy to have Steve Valenzuela, Chief Financial Officer of Alarm.com, with us here today. We've got about 25 minutes here together. Let's take maybe the first 15 or 20 minutes or so for some fireside chat with Steve, which I know is going to be fun. And then in the last 5 or 10 minutes or so, let's make this interactive. If anyone from the audience has got a question, just feel free to shoot me an e-mail at [email protected]. I'll be sure to weave your question in towards the end. So with maybe that as a framework, Steve, thanks so much for being with us here today.

Thanks for hosting us. You guys always run a great conference. I think this is almost our fourth year now, I believe. You've given us a full day of 1-on-1. So you keep us very busy.

I'm glad. Well, you guys do that yourself with the metrics that you folks put up, so kudos. And I reiterate, I mean, glad to have you back at the conference. Steve, just for folks that -- for folks on the stream that are maybe new to the story's.

Sorry, it's maybe a little bit of a high level question, but I think important to level set. Can you just sort of describe what Interactive Security means? What Alarm.com is providing and how you're monetizing it? Sorry, there's a lot there. Does that make sense, though?

Absolutely, that makes sense. And before I begin, I should mention that there is a very thorough investor presentation at alarm.com, under Investors. And then if you click on the first few pages, there is the safe harbor, which I need to say that this presentation and our discussion and the one-on-ones are all subject to the safe harbor. So with that out of the way, yes, very happy to share with you what interactive securities means. And Alarm.com really was the innovator here. So the big differential here, and again, this applies for residential and commercial customers is that with Interactive Security, it's a smart home system that you can actually interact with your security system and all of your smart devices outside of the home or even inside of the home with your smart device. The difference being the legacy systems like Honeywell had prior to Alarm.com. You would come home punching your key pad and there's still a lot of customers out there that have that. You punch in the keypad on the control panel, you activate or deactivate, the alarm couldn't interact with your alarm system outside of the home. Interactive Security really means being able to interact with your security system through your smart device inside the home, outside the home. And the key distinction here is you can use your iPhone, your iPad, your computer, to interact with your security system. And now we have a lot more smart devices, including video and video analytics, that's really been a big game changer. And I'm sure we'll talk about that. But that's probably a good, I think, maybe introduction or overview. And Alarm.com really focuses on the software. So we provide a cloud-based software that we host for the dealers. And that's really our focus is providing the best technology for our customers, the dealers, who then, in turn, market and sell and install and service to residential and commercial customers. And today, we have over 9,000 service providers, who -- we call them service providers, even though they're independent businesses and dealers, we really work closely with them in terms of go-to market, in terms of training. And then we have over 6.8 million end subscribers.

Got it. That's really helpful. I think it's kind of apart for the course, every company that we've kind of -- that we've hosted here over the last couple of days, to ask about COVID. And so maybe the question here for you, Steve, is I mean, 2020 has obviously been a very unusual year, a lot of abrupt changes have happened in terms of buying habits and digital priorities. Can you just maybe give us a sense for how Alarm.com's business was impacted either negatively or positively, even perhaps, by these global lockdowns and work-from-home orders we all went through and are going through?

Yes. No, that's definitely a timely question. In the March time frame, when the pandemic really initially hit and all the shutdowns occurred, we had talked about, in our Q1 earnings call that the activations were at about 70% of pre COVID levels overall. And what we've seen since then is in North American residential a very good recovery. As a matter of fact, in Q2 and Q3, we saw a V-shaped recovery. And in Q3, you could even argue that our activations were actually higher than pre-COVID levels. However, commercial certainly has -- been impacted the most, as you would expect, with commercial businesses, both small business and regional businesses, who we sell to, have been impacted because of the shutdowns. And even when restaurants and stores, coffee shops and businesses were not able to -- were able to open at 25%, they weren't able necessarily to install security system. So commercial's been impacted the most. Commercial has seen a bit of a recovery in Q3 over Q2. And Q2 was a little bit better than Q1. But we're probably running at about 70% of pre-COVID levels or so for commercial. And then international has also been impacted more than North American residential. Part of that is we have a number of new dealers who are ramping up and launching and replacing legacy systems that were delayed because of COVID, especially in Europe or some of the countries were shutdown and there had -- there was more stringent shutdowns. And so those new dealers will be rolling out there, the Alarm.com system to their existing subscribers, but it's going to take a little bit longer. So overall, I think that we certainly would have preferred not to have COVID. Overall, I think we would be doing better without COVID. Our results would be better, and we're looking forward to next year, 2021, when, hopefully, it's going to be safe to move around. I do think that a little bit more in North American residential, I do give a lot of credit to our dealers, our service provider partners who have figured out how to operate in this environment. A number of them got the funds, PPE funds, and then they also used the equipment and -- protective equipment to be able to work in the homes and be able to make the customers comfortable that they were able to have technicians come in and check to make sure that the homeowner was not around, and so they've been doing a great job there. So I think that's really helped North American residential. Then I think another factor is that when you think of Alarm.com, our systems have mainly gone into homes and second homes, not so much into apartment houses. And so the trend, certainly, we've seen this year, which is pretty clear is that people have either added second homes in the suburbs or they've moved to the suburbs. And that is a perfect target market for us and our dealers. And so we think we benefited from that as well. And I think that's a trend that's going to continue. The great thing about the system -- of the Alarm.com system is once you have it, it's very sticky. You get all these benefits every single day, especially now that the system is not just an alarm system, but it's a smart system, where you can remotely interact with the thermostat, you can see if your garage doors are closed, you have video cameras, video analytics. So there's a lot of value out there. So we're really excited about how well we've done in North American residential. I'm looking forward to, hopefully, a recovery in commercial and international next year.

Yes, absolutely. That's actually a great segue into my next question here, Steve. I mean, definitely want to be able to double-click on international and commercial. But I'd love to zoom-in on U.S. residential first. Maybe the question is, can you just -- broad brushes, of course. Can you just talk about how big that market is? And how much of that you think Alarm.com has captured so far?

Sure. So last time there was a market study done by Parks Associates. It's a couple of years -- about 3 -- or 3 years old, so it is a little bit outdated. And Parks Associates is a research firm that focuses on security and that market. What they identified was there's about 24 million homes in North America that have professionally monitored security systems out of about 140 million homes. So of those 24 million homes, only about 8 million have Interactive Security, meaning that's our market. And again, just about a year ago, we announced we had about 6.8 million subscribers. So we certainly have a large market share. So the difference between that 24 million and 8 million are the homes that have the legacy systems that are not interactive. They're landline-based. They're -- the keypad and punch-in at home. And so there's -- what we've been benefiting from is not just the overall growth of the market, but also the conversion, if you will, upgrade your systems from the legacy systems to Interactive Systems that we invented, including the -- system is being a cellular-based. It has a lot of capabilities, a lot of smart features versus the legacy systems. And so what's driving that is all these applications that we've come out with. And -- including better video cameras, the smart thermostats, video analytics has really been a game changer. We came out with video analytics a couple of years ago based on an acquisition we did back in March in 2007 -- January 2017, where we acquired a company called ObjectVideo that was doing a lot of AI for the government. They had about 17 employees, a lot of PhDs and video analytics. And we've added to that team quite a bit and increased the amount of engineering focus there and come out now with the system, the neural network system that can identify and distinguish between people, animals and vehicles and a lot of activity that's occurring. So both commercial and residential customers can use that for smart alerts. And so it's been really very helpful and very value added.

Got it. Got it. Maybe building on that topic of video, Steve, I mean, one of the things that we've talked about in the couple of years you have been in -- the few years that you've been coming to the conference is sort of the importance of video. The importance of video for dealers to generate higher ARPU, right? From their customers as well as provide customers with richer security services. And so maybe the follow-on question to that is, where are we in video adoption here? And remind us maybe, broad brushes of course, how accretive that could be to Alarm.com ARPU, if you will? Does that make sense?

Yes, it does. Definitely. It's a very good point. Yes. So starting with where we are with video, a couple of data points there and metrics. So a little bit more than a year ago we talked about, within a quarter, the attachment rate of video for new subscribers was around 25%, 30%. This last quarter in Q3, the attachment rate, meaning of the new subscribers what percent included video, was around 40%, and about half of those had video analytics. And that's important because if you have -- if we have a subscriber that has video, we're charging the dealer a little bit more. If you think about the average ARPU we charge the dealer for residential, would be in the mid-$5 range. If the end subscriber has video, then it's probably going to be closer to $6. And again, it depends upon the dealer, but just giving you some averages. $6 per month we charge the dealer. And then for video analytics, we charge an additional $0.80 to $1 to that dealer. Now the dealer, in turn, charges to the end subscriber for residential, on average, $45 to $55. If the system includes video analytics, they're probably on the high-end of that and maybe even a little bit more. So the model that we've deployed is one where we don't really raise prices to dealers or haven't in the past. What we do, we provide new features, new services, if you will, solutions that the dealers can then also pass on higher value-add to the end subscriber and then also charge a little bit more. And a good recent example is Flex IO that we just introduced in Q3 that we're really excited about. This is a sensor that can now be used for sheds, for gates where you don't have electricity, and you don't have Wi-Fi. So it's cellular-based and battery operated. We've gotten very good feedback from dealers on that, and it's new. So we'll see the ramp that we would expect that, that should be very -- should do really well. And that's another example of where we will be able to monetize that by charging the dealers $1 or $2 more per month per sensor and then the dealers can charge a little bit more to the customer. And these numbers are all residential. For commercial, the ARPU is closer to an average of $10 per month, and we charge the dealer. And then the dealer charges the end customer, the cushion business, on average, around $100 per month. That's for Alarm.com for Business. And then on top of that, we have access controls for business where if a customer -- commercial customer has access control, then we charge that customer -- that dealer, $3 per door per month, which can add up pretty quickly. And then if the commercial customer doesn't have Alarm.com, they can still have access control, and we charge the dealer $4 per month per door. And that's a new offering that we came out with a couple of years ago. And it's new. So it's been relatively slow in terms of the ramp on that one, because there is some training involved, and there is some hardware that has to be installed on the doors. But now we probably have over 1,000 dealers that have been trained and installing access control. Whereas for commercial, over 50% of our commercial service providers, dealers have installed the commercial offering in the last year.

Got it. Got it. That's a great segue into the topic of commercial here, Steve. I mean I'm not sure if it's in quite a year yet, but Alarm.com acquired a company called OpenEye that really gives you more enterprise exposure, right? With a SaaS solution, if I'm not mistaken. Can you just give us some thoughts on how the integration of OpenEye has gone? And what benefits they bring to the table here now that you're -- yes, what benefits they sort of bring to the table, if you will?

Yes. So we actually acquired a little bit more than a year ago in October of 2019. And OpenEye was not looking to be acquired. They were actually raising their first go around. They had been self-funded. And we came across them and realized that this is a company that has the same culture of Alarm.com, a focus on technology, very good customer satisfaction, very much focused on customer service. They had about 420 service providers, dealers, only about 15% overlap with Alarm.com. And so we saw a good opportunity here to take our commercial offering, which is really targeted for small business and expanding that into the enterprise. And so what the OpenEye provides is a cloud-based enterprise solution for businesses like Olive Garden, Gonzaga University. There's other large customers we can't talk about with the national franchisors. And so they sell through these integrators and also through universities and schools. So it's a great complement and a great expansion of the Alarm.com offering and expand this into a $4 billion TAM market for the enterprise segment of commercial. And prior to the acquisition, OpenEye was really providing, again, a cloud-based solution, but they were pricing it as a term license to get the payments upfront. We've come out now with a SaaS offering to increase the SaaS revenue from OpenEye, whereas prior to the acquisition, their SaaS revenue was fairly small. For 2020, the SaaS contribution of OpenEye will be about $1 million, but we expect in the future years that to go up quite a bit, now that we've come up with a SaaS offering for OpenEye. And in fact, for the Alarm.com dealers, they can only sell a SaaS offering. And so we think it's a great offering. The integration has done really, really well. Matter of fact, we've actually been investing in engineering. We've added more sales reps because OpenEye sales is more of an enterprise sale because the team at OpenEye is working with large integrators who are selling into like large franchisors, university systems, and so that does require a consultative sale, enterprise sale. So we've invested, added a few more sales reps. And we probably would have added more had it not been for COVID, but we'll probably add more next year. And we're expanding their facilities. And what's nice about OpenEye as well, they've retained -- we've retained all of the management team and, I think that's part of the philosophy that Steve Trundle brought over from MicroStrategy. If you remember Steve Trundle incubated Alarm.com and MicroStrategy for 8 years when he was CPO there. And so when we acquired these companies, we retained the management team. And that's very important to us, and we really scrutinize and we look at part of our diligence to mention the team to make sure that they have the same motivation as we do. And so the good news with OpenEye is all their management team that's been retained. They still have their identity. They get the benefit, of course, of our overall G&A and our ability to fund operations and help them grow. And so I think what the OpenEye team saw here is a company where they weren't selling out, they were joining up. And that's the kind of companies that we like to acquire, where they still have an identity, very much like Steve was incubating Alarm.com and MicroStrategy, OpenEye still has its identity, but they get the benefit of overall G&A and overall marketing. They have, of course, their own marketing. And we've -- actually are expanding their operations in Spokane, Washington, which is a new regional area for us. So we can tap into some of the engineering talent in the Washington Seattle area, which Spokane is a few hour drive from Seattle. So we're pretty -- we're very excited about OpenEye.

Yes, absolutely. Definitely a thoughtful M&A strategy by Steve Trundle and the team. I want to -- in the time that we've got left here, Steve, I mean, I want to maybe shift and talk a little bit about ADT, right? Because you spent a little bit of time on this on your last call. I believe Alarm.com's agreement with them was due to expire in mid-2021. And Steve Trundle, I think, talked about the renewal and extension here. And so I'll open it into question to the extent you can, anything you can share on how that contract is changing? And perhaps how other parts of the business could be important as that contract changes, I think, in 2023? There's a lot there. Does that make sense?

Yes, yes. So we talked about on the call that we extended our agreement with ADT, which was set to expire in August of 2021. We extended that to the beginning of 2023. And we're excited to do that. We have a great relationship with ADT. And the way the agreement is, is that Alarm.com will continue to operate the end customers of ADT both, those ones that command and control and on Connect, their pulse application that we license through that, through their natural life even after the contract expires and then subject to the churn rate. And then for customers that ADT adds on to a system that they're hoping to come out with, they would pay us a license fee in recognition of all the patents we have. So the good news is here is we've -- both ADT and Alarm.com came together, and we have a great relationship with them. And we're continuing to support them. And in 2023, if they need more time, we'll be there. And so throughout this whole process, it's been very good. And ADT has been very clear to let us know that there's -- it's really more about their goal of having an own system -- their own system is nothing that Alarm.com did or didn't do. We've been a great partner to them. It's more of an initiative they have internally. And so we're happy to have renewed the agreement with ADT and extend it 2023. And then in the meantime, we're continuing to invest in our growth areas. We've talked about and to answer your second part of your question, the growth areas that we've been really investing in, the larger ones are international, commercial, video and video analytics and energy. EnergyHub, which is doing really well. That overall group represents about 22.5% of our revenue and grew over 40% year-over-year, even in a situation with COVID, and that does not include ADT. So we think that we will see continued good growth there, especially after COVID. And so we're excited about the opportunities there, and we're obviously investing in other areas as well, just like we came out with Flex IO, we came up with the Smart Water Valve+Meter. And so Alarm.com is very much focused on a engineering development effort where we continually come up with new innovations, new products, new technologies to make sure our service providers have latest and greatest technology. Because they're all competing against each other. And so all the service providers of Alarm.com benefit from our overall R&D effort. And then also, of course, we're hosting all this data for them in our cloud. So they get a lot of economies of scale, and they get the best technology. We're continuing to invest in our AI neural network. So we have the best AI system out there. And so the Alarm.com dealers will continue to benefit from that level of investment. And it will be hard for others, I think, to keep up, quite honestly.

Yes, sure. No, definitely a lot of seeds planted here over the years, we've definitely seen that. Steve, maybe in the few minutes that we've got left, I've got so many more questions, but unfortunately limited time. One of the things that's always helpful that Alarm.com does, particularly in their Q3. So maybe give some broad brushes on what the out-year guide could look like? And I think one point that's worth calling out here is the profitability in the business, even with the hardware business, as part of this. I guess the question is, can you just remind us what you said about EBITDA profitability for next year? And maybe what are some of the moving parts to consider in that? High level, of course.

Yes. So we started this a couple of years ago, providing an initial look for the next year. So for, like you said, in the Q3 earnings call, we gave an initial look. It's not really our guidance. It's more, hey, we're in the planning process. Here's where we are seeing Q -- 2021 at this point in Q3. And part of that reason is because the time between the Q3 earnings release, beginning of November, to when we issue our financial results in February, going through an audit is a fairly long period of time. And we respect analysts like yourself that need some guidance. Anyway also don't -- when you get too carried away with the brilliant results we have. So we like to put out some initial feelers out -- initial numbers out there. And we talked about on the Q3 call, the EBITDA for 2021 would be around $120 million, which is just a little bit shy with 20% of revenue. And that's kind of been our target, 20% to 25% EBITDA. And that's in a situation where we still -- in those initial numbers still have to factor in that we still have COVID. We're now planning, in those numbers, that there's a full recovery. We still believe -- while we still anticipate or plan for some headwinds in commercial, some headwinds in international. And if we're surprised and pleasantly surprised then we'll have some good upside. But that's kind of how we look at it and the numbers we came out. With that $120 million, we generate a very good amount of cash flow. So typically, around 60%, 65% of EBITDA flows through cash flow. This year, we'll do over $65 million of cash flow. So we generate a very good amount of cash flow. And at the same time, we're still investing very, very good rate. 25% of our revenue goes into R&D. And so we're continuing to make the innovations and investments while generating a good amount of cash and EBITDA for our shareholders and providing a good return. We think that's the right model.

Got it. Got it. Well, again, Steve, as I said, a lot more to dig in here, but unfortunately, limited time. Thanks a ton for being with us here today and look forward to being able to do this in-person again in San Francisco like we have in the last few years.

Saket, I definitely look forward to doing this in-person next year. Absolutely. Thanks.

Same here. Absolutely. Bye now Steve.

Take care. Bye-bye.