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

Yes. So international is -- we think a great opportunity for us. It's only 4% of our revenue today. But if you think about it, it really should be 25% to 30% of our revenue at some point. Now I'm not saying when. So I'm not giving guidance, but the opportunity is certainly there. And the way we're going to market there is similar to the way we grew North America, really signing up service providers. But there are some complexities internationally. And some of that has to do with the control panels, the cellular networks and some of the countries are different. And so 1 of the things actually we announced today is we acquired EBS, a Polish manufacturing company that has a communicator that's going to allow us to be able to go to market in many different countries quicker and be able to enable those service providers to be Alarm.com dealers. So for example, Europe is an area for us that's been doing quite well. Australia, New Zealand, South America has been doing well. We think there are some opportunities in Asia. We're not in China. We're not in India yet, but we're probably not going to be in China, but we might be in India at some point. But international, we think is a very good opportunity for us.

Okay. And then just on the -- moving back to commercial, where are you seeing some relative strength across regions and verticals, especially verticals, I guess.

Yes. So in commercial, so again, commercial, you have SMB, which is like think about like somebody who owns 6 or 7 different restaurants in a geographic area, that's really we've started out with. We took the Alarm.com residential system, and we had our engineers spent some time with restaurant owners, coffee shop owners in our area and learn and adapt the residential system to be configured, if you will, similar to residential, but more geared toward a commercial business to be able to operate 6 or 7 different restaurants. That's SMB. Again, for that, we charge a higher ARPU typically $10 to $20 per month. And then you have commercial enterprise, and this is really how we got the market there was acquiring OpenEye back in -- I think it was 2019. We acquired OpenEye, which competes with like Verkada and EcoEye, and think about large commercial properties, think about large theme parks, franchisors, schools, universities, Gonzaga University as a customer of ours. And here, you've got maybe thousands of cameras deployed and you have to have the technology to be able to quickly again see what's happening across those -- across the property with thousands and thousands of cameras. And one of the things we've recently done for the commercial segment is actually add a third-party camera support. And that's important because if you think about a lot of businesses have a legacy security system because they have to have a security system because of their insurance requirements. But again, most of those are legacy systems, and they have cameras. So by being able to use and not have to throw out their cameras, that saves the end customer money and allows us to implement our solution and have the recurring SaaS revenue. So that's been, I think, an important development for commercial enterprise.

Yes. And then -- you touched on the AI program before, but where are you seeing opportunities there? And where are you deploying some of the solutions and some examples there?

Yes. For commercial, for example, one of the things is being able to do line counting. So imagine if you again have a coffee shop in 6 or 7 different coffee shops in a geographic area or you have a Chick-fil-A where you have the line of cars, which has typically has a lot of line of cars, but you can -- our system will do line counting, to be able to tell the owner or the manager at which location has the longest waits and then they can send employees from 1 location to another location. That's 1 of the things that we develop with our AI solution. Another one, of course, is being able to tell if there's somebody staying in the back of a property for longer loitering and alert the property owner that there may be trouble back there. But another solution we developed is AB testing for like retailers to be able to say, okay, if I put the merchandise on this line versus that line, which line is actually the best location for my merchandise. So that's for commercial. For residential, again, it's being able to give smart alerts to the customers that there is a person in my property, and you can actually set a zone where you can identify if somebody comes in that zone, then you'll get a smart alert. You can also identify vehicles and animals again. We haven't got to the point yet where it tells you what kind of animal or we haven't got to the point yet where it actually tells you if it's your vehicle or your families vehicle, we're working on that, of course. And then one of the things that would be very important for residential to be able to identify an alert if someone goes into a swimming pool, right? And a customer would pay a lot of money for that. Now we haven't perfected that yet, and we wouldn't come out with that until it's 100% perfected, but we think there's a lot of opportunity with AI and capabilities such as those applications and those solutions that are specific to certain needs of our customers.

All right. So let's talk about some of the growth areas that you're expanding into, start with energy management at EnergyHub. How big can this business be? And what's your footprint now? And how is that expanding?

Yes. So the other segment, which includes EnergyHub, is a little bit less than 8% of our SaaS revenue but it's growing at about 20%, 25% per year. So it's growing faster. EnergyHub is part of that segment. And we actually acquired the business, I think it was around 10 years ago, and it took a couple of years, but they became over the last 5 years, I would say they've become the de facto standard for residential demand response for utilities. A number of large utilities, which I probably can't name our customers of EnergyHub. And the way this works is that EnergyHub works with the utility to be able to implement the demand response system, the utility markets to their residential subscribers to join the demand response network. EnergyHub also enables the utility to market to those end customers. And for each customer that joins the demand of response, system EnergyHub [ consists ] recurring SaaS fee. And so that's grown over the years as, of course, the energy demand on the grid has expanded. And now what's happening is with EVs, when somebody brings an EV home, it's like putting like a whole block demand on the grid. And so that's really caused a lot of need for more demand response. And so EnergyHub is developing some unique solutions for EVs, for utilities that we think is going to be quite compelling in the next couple of years and really help to drive growth. So we think that business could be quite large. I can't say exactly how large, but it is growing faster than the overall residential business.

And then PointCentral, you have some incumbents in the space, how is that business doing?

Yes. PointCentral is both for multifamily. I think like apartment houses being able to mainly have access control, and also for vacation properties. So we have a solution there where if you have, let's say, you have 4 or 5 different vacation properties instead of the tenant, the person having to go get a key, they get an electronic key to open the door and they also have the thermostats that they can remotely manage and also to be able to manage the sensors. It's less about security, more about access control and being able to manage the property. That business is a smaller part of our revenue stream today.

And then Building36 as well?

So Building36 is another -- it's actually based in Boston here. They really are the backbone of building our thermostat system. So we sell a lot of thermostats. And so Building36 has built those thermostats and developed the technology for the thermostats. We've also recently come out with smart water valves and what we call the Water Dragon. So we can sense and alert you if there's a break in your property in terms of the water main or for using too much water. The smart water valve plus meter actually gets installed where your water main comes into your home. So that is -- that does require a plumber, but recently came out with Water Dragon, which actually clips onto your pipe and it actually uses a technology to be able to tell how much water you're using here. If the flow of water is too high, it will send you a smart alert. You could set the alert either way, if you want a low flow or a high flow alert, you can actually set those alerts. So we think that, that's pretty compelling solution especially in the Northeast, where you have a lot of pipes and a lot of water breaks and because of the freezing weather or if you have a vacation property, right, you want to make sure you know if there's something going on with your water.

Cool. So that's all really cool stuff. So moving to gross margins. SaaS side is strong, but you see kind of fluctuations on hardware, what are longer-term hardware margins and kind of overall margins as we think about that?

Yes. Last year, Q1 of 2022, the hardware margin was 11%. That was when we were really at the height of the supply chain dynamics. The challenge is we had to air freight and a lot of products from Asia and that costs us a lot more than, of course, shipping on the water, which we're able to do now. The good news is that Q1 hardware gross margins were 23.7% and that's in our normal 23% to 25% range is where we would expect hardware margins to be. Interesting about the hardware margins for commercial, it's actually higher. It's more like in the 40% range whereas residential hardware margins are more in the 20% range. So as commercial continues to grow, we should see hardware margins over time increase. Now the good news is 65% of our revenue is SaaS, and there, we have high margins, 85% to 86% gross margins. And so that's been very resilient, very predictable.

So as we move down the P&L on OpEx, where you targeting investments across G&A, R&D and where do you see some leverage in the model and then kind of longer-term targets and the kind of path to rebound here after Vivint hit in '23?

Yes. So one of the things we did do in Q1 is we did a little bit of rightsizing because we've hired a lot of people in the last couple of years, like a lot of companies, not at the scale of Facebook, but we did do about a 3% or 4% reduction, mainly performance management in terms of people that have joined that really come up to speed at the right speed or you right to scale, if you will. And so we made those reductions to bring down some of the cost structure and realign some of our investment areas. But the area that we really invest in is R&D. So that's about 28% to 29% of our revenue. You would think that once we get to a steady state, the R&D should be in a normalized 12% to 14%. And therefore, our EBITDA margin should be in the 30% plus. Now I can't say when that would occur. In the past, we have been at 30% plus EBITDA margins before we went public. And so our model is definitely 1 that's very flexible and very resilient and 1 where we could certainly see a return to 30% EBITDA margins at some point in the future.

Okay. So I have some more questions, then I'll open it up to the audience if anyone has a question.

I have a question on the EnergyHub. I mean the whole distributed energy management space is quite interesting. So it involves not only the EVs, but also like solar panels and storage assets. So can you maybe share a little bit more on how the EnergyHub kind of play into this area? And like what are the constraints for the growth in the future? Or any kind of I guess, things that either on the regulatory side or on the market side that is kind of hindering your growth on that area?

Yes, that's a good point because EnergyHub -- the energy demand and the demand on the grid we all know is increasing, electric vehicles are going to increase that, as I talked about. But so what EnergyHub does is they work with the utility companies to really provide the demand of response for residential customers. And so the residential customer of, let's say, Duke Energy, for example, would be marketed to from Duke and they would join that demand response, that subscriber would get a reduction on their energy bill, a little bit of a discount. And then the utility can actually reduce or manage their temperature remotely, they have to have a smart thermostat, of course. And so just even reducing the temperature by 1 degree or 2 degrees across millions of subscribers can really reduce the demand on the grid. And when a utility has to go out and buy energy on the open market, it's very expensive for them. And so by being able to save the demand, if you will, and reduce the demand on the grid really saves the utilities, a lot of money. So EnergyHub has that technology to be able to provide that solution for the utility for them to go to the end subscriber, the residential customer and provide that service. The same for EVs. And in fact, for electric vehicles, there are some different technologies that EnergyHub is working on with the utilities to provide some unique solutions. For example, when people come home and typically, they plug in their EV 6:00 at night and 6:00 to 8:00 is like the highest demand on the grid. And so there's some technology that EnergyHub has that actually knows which customers are going to leave that plugging in overnight and so it will slow charge from 6:00 to 8:00 and then it will start charging faster overnight. So that, again, it reduces the demand on the grid during peak times. So that's just 1 of the many solutions that EnergyHub provides. We think that there's quite a bit of opportunity here. It's actually -- EnergyHub has grown quite well over the last, I would say, 5 years. And they've really become de facto standard for residential demand response for utilities. Today, when utilities are looking at demand response and more and more are because of all the energy needs and all the energy challenges they look at energy up for the most part.

Okay. Let's talk about -- Oh, 1 question.

Just 1 on ADT. I think you guys mentioned that they're going to be moving away from the platform in the back half. Can you just talk a bit about what that means for your business? And is there any risk that they or others could take the Vivint route, I guess, and try and stop paying licensing fees?

So we have over 11,000 dealers today. Since 2013, there's been 1 dealer who has actually come up with their own solution and that's Vivint. What you're talking about is ADT, Google has announced a few years ago that they would be coming out with ADT solution. We are a close partner with ADT. Our agreement with ADT is that we will license the technology as they come out with their solution and we'll be paid a license fee for that. But the important part is that we have an agreement with ADT that we will continue to manage their subscribers that are on Alarm.com called Command and Control & Pulse, which is what ADT Solution is for the life of those existing subscribers, which is 8 to 10 years typically. And then the new subscribers, when they do come up with their solution ADT would then pay us a license fee. I understand from what ADT has talked about is that will likely be in the fourth quarter is when they may come out with that solution. Initially, it was going to be beginning of 2023 and I think the latest from what ADT has talked about is they're looking at coming out with that at some point in the fourth quarter. But that's just publicly what they've talked about.

Then let's finish on cash. It's been in good shape historically, heavy investments in inventory. But how do we think about sort of cash flow and normalization there?

Yes. So we have been a very cash flow positive company. Over the years, we typically have generated $80 million to $100 million of operating cash flow, $80 million of free cash flow. Last year was a unique situation with the supply chain where we actually invested in inventory. So I think our operating cash flow last year was lower. It was about $50 million. I would expect now that as we get through the supply chain dynamics, we'll start to see inventory start to come down, which will then help, of course, our operating cash flow. One of the negatives that is occurring is this new tax law, Section 174, which is taxing R&D and requiring companies to capitalize their R&D and amortize it over 5 years. There is some potential discussion that, that would actually might be repealed. But effectively, what it does, it actually accelerates the tax to the recent years, starting with 2022 and then 5 years to 10 years, the tax will be lower. And so what that's actually done is that actually cost us $40 million to $50 million of cash per year. And just to give you an example, in Q1 of this year, our operating cash flow would have been around $30 million had we not had to make a tax payment of around $37 million. So it's not a real operating, but it's more of an acceleration of the tax. Now again, if that gets repealed, then we'll get back to a normalized $80 million to $100 million of operating cash flow. But otherwise, we have $606 million of cash. We do have a convertible that we put in about 2 years, 2.5 years ago, $500 million convertible. It's a 0 coupon, a premium of $147. And so we have a net cash positive of over $100 million, and we're generating cash. So we're in a very good cash position.

Well, we're out of time, and I want to thank you again for your time today.

Yes. Great to be here. Thank you.