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

All right. Well, hey, good morning, everyone. Welcome to day 1 of the Barclays Tech Conference. My name is Saket Kalia. I cover software here. Honored to have with us Steve Valenzuela, Chief Financial Officer of Alarm.com. I was going to say we have Matthew here...

Great to be here.

In the audience, but we...

Great to be here. Always a great conference.

Well, it wouldn't be a conference without you here, Steve. So -- well, maybe just to frame the time that we've got here. We've got about 30 minutes together. Maybe we could take the first 20 or 25 minutes just go through some fireside chat, which I know is going to be fun.

Yes.

And I would love to make this interactive. Any questions from the audience, don't be shy, just pop up your hand and we'll get a mic runner in the back. So again, Steve, thanks so much for being with us here today.

Yes. Great to be here.

Steve, I just want to -- just to level set for everyone. It was a great Q3 all around. I mean there were some really fun things to talk about. But just to make sure that we're all on the same page. Can you just walk us through some of the highlights that maybe you were particularly proud of.

Yes. Yes. Well, as CFO, I was very proud of our working capital and our cash flow. We generated $60 million of free cash flow in the quarter. We have $680 million of cash now, $180 million of net cash. We have a $500 million convertible at 0 coupon that's going to mature in January 2026. So we're not in a hurry to do anything with that. We're making good money on that...

I wouldn't be either.

But we're also very happy with the quarter in terms of the growth. So SaaS grew 13.9% year-over-year adjusted for [indiscernible] on a comparable basis. And then also, if you look at the EBITDA, it was 18.6%. So we're a Rule of 30 company plus really based upon that, Hardware was a little bit less than we expected, but we're fine with that because hardware is not recurring, and it's actually a low-margin business, 20%, 25% gross margin business. We make the margin on the SaaS, and that's really our focus.

You're a SaaS company, right?

We're a SaaS company. And that's where some investors would get confused when they look at the overall growth of the revenue. Really have to look just at that SaaS. SaaS is highly predictable, highly reoccurring. I like to say it's the gift that keeps on giving, especially with the renewal rate of 93%.

Yes, for sure.

It's been consistent for the last couple of years.

Absolutely, absolutely. Maybe on your point around EBITDA just on the margin, but what I found really impressive was the EBITDA dollars, if I'm not mistaken, are roughly unchanged year-over-year despite not having Vivint in there from a revenue perspective, despite some of the litigation expenses, so really showed some of the operating leverage in the business. Right?

Yes. Yes, there is a lot of operating leverage in the business. We've been investing over the last couple of years very heavily in R&D. About 28% of our revenue has been invested in R&D. Now at some point in the future, that's going to come down, right? But we've diversified the business from North American residential security to international, to commercial to energy and so we've built a very diversified business, HVAC water. And so those investments are really paying off, as you've noted, where now 30% of our SaaS are the growth businesses that are growing faster than 25% year-over-year. North American residential, which is our beginning of the company, our core market, if you will, is growing slower, but the growth businesses are really kicking in, if you will, with based on the investments we made in R&D, we'll continue to see that growth going forward.

Yes. Absolutely. A lot of fun topics in there that I'm going to dig into a little bit deeper. But maybe just to step back, I want to talk about just the interactive security markets a little bit. How do you sort of think about the market for professionally monitor homes, right, which I think is one component of it? And then how many of them are going to have interactive security, which I'll just define as something that you can sort of manage with your multiple device here as well? So any sort of thoughts on that TAM? I'm trying to -- I know that there was some TAM numbers that you put out years ago, but I was wondering if you kind of have those numbers handy.

Yes. So for North America, there's about 140 million to 150 million homes. About 30 million of those have professional monitored security, meaning that there's a control center, a central station that's monitoring. About half of those are interactive. The other half are plain old landline, you can't use -- you come home and you punch in your keypad that's all you can do. Alarm.com innovated the interactive security system many years ago. We converted it to cellular base. So if you look at that 30 million homes that have professionally monitored security, about half of those have interactive security. And at the end of last year, we announced we had 9.1 million subscribers. So of course, now we have more. We only update that once a year. And so we have -- we're certainly the market leader by far. The next competitor, if you will, is Resideo, which I think last they reported was sub 2 million subscribers. So clearly the market leader. We're continuing to innovate, continue to invest. And we're expanding that, of course, to international, which, by the way, international is as large as North America. And we've only tapped a very small portion of international. It's only 4% of our revenue. But we acquired a company this year actually, EBS in Poland, that has a communicator that actually helps us get into various markets. Because when you go international, there's some complexities. So you've got to connect with different cellular carriers and then you also have to connect with different control panels because we don't make the control panel. The control panel, that is part of the brains that goes with the security system, we interact with Resideo, with Qolsys, with 2GIG. These are user control panel manufacturers, JCI. And so you have to integrate with those in various different countries. And so that's going to help us accelerate the growth international.

Yes. Really interesting that international is just as big of a TAM as North America.

It is.

It's interesting you said that. I didn't realize that.

We haven't even touched the surface. We've done well in Europe. We've done well in Australia, New Zealand, South America. We haven't done much in Asia yet. But there's a number of opportunities in Japan that could be quite significant.

Interesting. Interesting. I think that sometimes we see the do-it-yourself products out there, right, or the DIY products like a Ring, for example, right? Maybe the question is, how do you think about the DIY market versus sort of a do-it-for-me type of Alarm.com customers like myself, by the way, right, if anyone wants to see the alarm, let me know, that choose to have something that's professionally installed. How do you sort of think about those contrasting markets?

Yes, that's a very good point because we go to market through our service providers. We have over 11,000 service providers. These are independent dealers who actually are the ones that are marketing to the end subscribers. They're installing the systems. They're basically providing the central station. They're also providing the renewals. We provide the technology, the hosted SaaS technology, for them to be able to operate both their commercial and residential security systems to their customers as well as the back end. So there's a lot of technology that we provide that the end subscriber doesn't see, the service provider sees. And when you look at it on a DIY basis, DIY has basically been the bear case for Alarm.com for the last 10 years. Ring acquired Nest -- I'm sorry, Amazon acquired -- Google acquired Nest. Ring was acquired by Amazon many years ago, and there was all this concern about DIY. We continued to grow during that period of time because the reality is that the DIY customer is different than yourself, who's busy, who you want to professionally install it. You're traveling. You want to make sure that security system's going to work when it's needed, right, the one time. Are you going to trust yourself, your family with your -- if you're own do it yourself? So there is a market for DIY. Arlo is a good company. They've done well with their battery [indiscernible] cameras, but it's not a competitive offering, if you will against Alarm.com. What's interesting, too, if you think about the history here, look at Amazon. Amazon acquired Ring, like 5 years ago, right? They came out with basically their own security system a couple of years ago, and they've done well with the doorbell, but they've not actually penetrated at all, the do-it-for-me market. Google came up with Nest Secure in September 2017. We know that because they partner with 1 of our service providers, Brinks, to do the monitoring. That was a failure. Matter of fact, Google canceled that product, and they were trying to get into their do-it-for-me market. And now 3 years ago, they invested $500 million into ADT which we'll talk about it. But the do-it-for-me market is definitely the preferred market. For commercial, there's no DIY for commercial of course and more for residential as well. The high-end homes, for second properties, it's really where the growth is. Now there's companies out there like Ring. Some of our subscribers actually have a Ring doorbell. They've done a good job with the doorbell, but the subscriber still wants a complete security system that they can trust from their service providers that they can actually reach out to, touch, they can have them service their property, not this big conglomerate where you can't even and get a hold of anybody like an Amazon or Google who are good companies, but they do a lot of other things. Our service providers are focused on providing the security. And we go to market basically security first. We've added more features to make it more interactive, make it a smart property. And in fact, a lot of new subscribers use the security system to see what's happening around their property, to see when their kids come home from school, right, to see the animals. I always have like a fox that comes around my house pretty much every night and I can see the fox coming around, making sure it's not going to touch my dog. So it's amazing. And we haven't talked about AI yet, but we actually acquired a company in 2017, ObjectVideo that was doing work for the government based in Reston, Virginia, that we took that team of about 20 PhDs and software analytics and redirected them to AI for video. And then we supplemented that team and, in fact, this year, we acquired a company called Vintra, that actually was based in Silicon Valley, had about 20 PhDs in Spain and what they've been able to do is actually enhance AI system, to not only provide smart alerts but also for commercial. One thing we've recently come out with is for commercial, think about big enterprises, right, being able to see where there's bad actors, that technology that Vintra gave us basically allows us to track a bad actor across thousands of cameras, not using facial recognition because there's some bad conno-technics with that, so not using facial recognition, but actually just being able to classify that person and being able to track them across multiple cameras so you can see what's happening with that person and where they might be going. And so AI is a big part of our solution, and we think it's going to be a gamechanger for the future as well, not just for residential but also for commercial.

Yes. Absolutely. Maybe just the last couple of questions here on the residential security. Because I want to talk about some of the other areas that you touched on as well. I often get questions about new home sales, right? And so I want to address this kind of head on. Maybe the first question is, how significant of a business is new home builds for Alarm.com? And then secondly, in this sort of home buying environment, right, with mortgage rates where they are, of course, what are you seeing in the model when it comes to things like new subscribers of retention rate? A lot there. Does that make sense?

Yes. No, absolutely. So new homes, retention rates. So first of all, we do have D.R. Horton, Toll Brothers and most of the builders and even local builders as customers. That said, new homes is a few percentage points over new subscribers. It's not that large. And it does add maybe 100 basis points or so various -- depending upon if the new homes are increasing or not, but it's not that large of an impact on our subscribers, either plus or minus. Because what's happening is people are hearing from the neighbors, they're remodeling their home, they're putting in a security system. The world is not getting any safer, right? And so homeowners are putting in cameras, they are putting in system not because they bought a new home but because they want to be secure. The other thing that's really interesting about our model is during challenging times, during slow times and during high mortgage rates, people are not moving. Moves account for about 60% to 70% of our churn. So fewer people moving actually helps the retention, and we have a very high, very predictive retention, 93% net retention that's been consistent over the last couple of years. So it's actually contracyclical, if you will, for the business. And also when things get difficult and a difficult economy, there's more crime and people are more likely to have a security system. And when you think about the residential customer like yourself, you're probably paying -- you don't have to tell me the exact amount but you're probably paying the service providers anywhere from $45 to $65 a month.

Right in the mid point, right there. That's right.

And a streaming service is going to cost you more than that. What are you going to get more value out of? What are you going to turn off first? You'll turn off your streaming service, but are you going to turn off your security system that's protecting your property?

It's too mission critical.

And your home? And you put in all the cameras and you put in all the equipment. No, you're not. So it's very high retention. The lifetime -- the LTV to CAC of our subscribers is probably -- we haven't looked at it recently, but probably 7 to 8x and the life time is typically 8 to 10 years and sometimes even longer because once you have that security system, you're going to keep it. The other thing that happens too when people move, the new homeowner has already a lot of the equipment in there. And so it's very easy for the new homeowners to simply call the service provider and turn on the security system, maybe add a few more cameras.

Yes. Interesting. I have to do that myself, actually. I've got a blind spot in my side yard.

By the way, we have a new camera coming out, floodlight camera that is really cool, 729. What that's going to do, it'll obviously have the floodlight, but it's also going to have two-way talk. So if there is somebody that's loitering in your property, the central station could actually tell that person, you are being monitored. And it will flash red and yellow and it'll put out an audible alarm. That's coming out. I'm actually getting one myself.

Interesting. Yes, there you go.

You should wait for that.

Yes, Steve, maybe let me just sort of put a bow on kind of the North American residential part of the business. How big is that roughly? And you touched on this a little bit, but how fast is it growing?

So the North American residential is not growing that fast. It's probably in the single teens in terms of actual residential growth. But what's happening, though, is when you think about the 140 million homes, every year, more homes are converting to a security system. And then the 15 million homes that don't have interactive security are upgrading. Every time they upgrade, let's say ADT upgrades a customer from a legacy to an interactive, that's a new subscriber for us. It's obviously an upgrade for ADT. So there is a lot of built-in opportunity there in terms of the TAM expansion, but it's a big market. So the growth per se is not as fast as our overall growth in the commercial international video. Now video is a gamechanger though. And we think that that's going to continue to drive growth even for North American residential because of the AI capabilities. And we were talking about AI before even everybody else was talking about AI. But we're not trying to jump on the bandwagon here. We came out with our neural network in [ 2017 ].

I remember. Yes. Yes, absolutely. So maybe we'll use that. Maybe that's a good segue just into what I like to call the growth businesses here, right? Like I think to your point, I think team have sized these and it's about 30% of total SaaS, and it's growing in excess of 25% on a trailing 12-month basis. You correct me if we're wrong.

That's exactly right.

Maybe the question here to sort of level set for everyone is can you just remind us what's included in that? And maybe you could stack rank it, right, not too much sort of color, but sort of stack rank it by size and components.

Okay. Yes, that's fair. That's fair. So I would say commercial is part of that for sure. We started commercial and that includes [ S&B ] about 4 years ago. Then we have international and maybe video would probably be before international. Video and video analytics. And today, to touch on that a bit, about half of new subscribers actually have video, which I'm surprised it's not 100%, but 98% go with video analytics. The good thing about that is our ARPU goes up when you have video and video analytics. So we typically charge a service provider $5.50 to $6 per month for a base system. If the customer has video and video analytics, we charge for the residential subscribers $7 to $8 per month. So video is part of that. Video analytics is part of that. Energy is part of that, EnergyHub, which is our subsidiary, part of our Other segment, the largest piece, really interesting business. As a matter of fact, this last quarter, that business grew over 30% year-over-year, the Other segment, which includes the EnergyHub. And actually is almost 10% of our [ staff's ] now, where a year ago, it was 8%. So it's growing nicely. It's becoming relevant. Once it gets past 10%, investors tell me they'll start looking at it. So we're close, right. We're 9.9% last quarter. So we're almost there.

Moving the needle. Moving the needle. Maybe just to dig into a couple of those. I want to start with video, right, because I think it's really powerful. I'm a video user for myself, right, with the doorbell. What's driving that demand? What's sort of that adoption? And what's sort of taking that adoption rate up?

Yes. The video is really being driven by both residents and commercial by the way. So it's really the analytics that's really powerful of being able to have smart alerts. So if you have like an Alarm.com system, either residential or commercial, you can get a lot of different alerts. And if you don't have the right AI system built in, you can get too many alerts. You can get overwhelmed. So what's really driving it is being able to have these different use cases other than just for the alarm system itself, like to be able to see what's happening around your property, to see when your family, your kids are coming home from school, to see where your pet -- is your pet running around in the backyard. And so there's all these use cases. And then second homes is another big factor for us. So second homes, people want to see what's happening around their property as well. So video, video analytics, AI. And today, it's a very big opportunity for us because if you look at our 9.1 million-plus subscribers, only about 30% of those have video. There's still a lot of room for upgrades. And every quarter, about 15% to 20% of cameras are going to existing subscribers hopefully, like yourself who are going to upgrade and add more video capability, and that's going to continue to evolve. And so also the investment we made in cameras, now cameras are a lot smarter, there's a lot more capability. Doorbells, we've come out with our own doorbell now, where when somebody walks by your doorbell, it'll have a red and blue light and it'll set an audible alarm. So there's a lot more features now that make it much more usable I guess. There are many different use cases.

Yes, absolutely. The other kind of growth area that I want to touch on is commercial. And I think that's a really interesting one because it really feels like you and Steve Trundle have really built the portfolio here much stronger over time organically, inorganically. How do you think about the size of the TAM there compared to residential? And maybe it was really helpful kind of ARPU thoughts that you gave just there on video. Can you just maybe talk similarly what's the difference in ARPU between sort of commercial and residential as well, so the TAM and ARPU?

So yes, today, commercial is about 9.9% of our total SaaS and it's growing again faster than overall residential, right? And in terms of the ARPU, a typical like SMB customer that, let's say, you have 5 or 6 different restaurants in an area, the ARPU there is going to be $10 to $40 per month that we're going to charge that customer versus $5 and $7, so the ARPU's definitely higher. The other part about commercial too is we have access control, which is something we invested in many years ago, where the property -- the business owner can provide access to their employees, delivery personnel through their smart device, right? So they can activate or deactivate an employ -- a matter of fact, we had a recent customer of ours who gave us some feedback was very happy with her solution. She had 5 different restaurants. She had to terminate an employee, deactivated his access right away and that employee tried to come into the store at nighttime so she was able to prevent that problem. But access control is a small part of our commercial now, but it's growing pretty fast. So that's another component where we actually charge anywhere from $3 to $4 per door per month for that service. And you can imagine some businesses have a lot of doors, so that can scale up pretty quickly. So yes, commercial is a big opportunity. We also acquired OpenEye in September of 2019 that got us into the enterprise segment. This is not SMB. This is think about large universities, the large theme parks which I can't name, large franchisors, large malls, right, where you have to protect the property both inside and outside. And so here, what we provide is hundreds of cameras and we have a control station where the security officer can actually monitor these cameras and see what's happening around their property, and be -- make sure that there's nothing bad occurring or try to prevent something bad occurring. And so there's a lot of opportunity there. Now that enterprise tends to have more cameras. And it's -- when we acquire the business there, we're actually selling the software as a perpetual license software, not SaaS. So we've taken that software, put it into hardware and Other and we've now been increasing the SaaS offering. As a matter of fact, last quarter, that was about $3.1 million in SaaS, whereas when we acquired the company back in 2019, SaaS was $1 million for the full year. So it's also growing at a higher rate.

It's great. That's great. I want to pivot to some of your customers that it's a great model here, right? Like the dealers are -- they're your customers and, of course, consumers like me are their end customer, so it's almost like B2B2C, right? But I want to talk about ADT who I believe is your largest dealer customer. And of course, like you mentioned earlier, ADT's partnered with Google in residential home security. And I guess maybe the question is remind us of what you said about the size of this business for Alarm.com. And how you've contemplated this in your sort of preliminary '24 outlook.

Yes. So ADT is about 15% of our revenue. As you indicated, about 3 years ago, Google invested $0.5 billion in ADT. We got our business with ADT back in 2017 when we acquired Icontrol based in Silicon Valley. And ADT, we worked with ADT for 2 to 3 years to come up with their command and control version, which is what we currently have for ADT. And so when we look at the Google-ADT relationship, when we look at Alarm.com, we have a very good relationship with ADT. We're going to continue to service their subscribers for the natural life of those subscribers. And after ADT announced their agreement with Google, we worked with ADT on this agreement because we have millions of subscribers that we're supporting for ADT and ADT wants us to continue to support those subscribers. So what we've said is that going forward for 2024 and actually starting in the fourth quarter, ADT has announced they're going to start rolling out their ADT Plus solution. So we've baked that into our guidance. Now going forward, though, there's still going to be many subscribers coming on to Alarm.com that are ADT customers because it's going to take time to roll that out. Existing subscribers on ADT Alarm.com command and control are going to be staying on the system and we're going to be managing those for 8 to 10 years. So there might be 100 to 200 basis points slower growth which we've baked into our guidance coming from ADT new subscribers, but existing subscribers are going to continue to be there for a long time.

That's a very longtail, just like you've seen with Icontrol, right?

Very long tail.

93% retention rate, right.

Exactly. Yes.

Means an 8- to 10-year life, right? So that's pretty straightforward. I want to shift to some modeling -- actually, before we shift to some modeling questions, any questions here for Steve from the audience before we shift gears? Maybe from a modeling perspective here for you, Steve. I'm going to talk about the -- I'm going to touch on the hardware business a little bit. Again, we're a SaaS company, right? But -- and it's clearly not the core business. But there has been a decent size from just an absolute dollar perspective. How are you thinking about hardware growth in '24? And just going forward in general?

Yes, hardware, really we priced hardware basically at the minimum margin because if you think about once we make a sale on hardware, we sell to the dealer who sells to the end subscriber, it's a onetime sale, we want that fast. So we price our hardware at 20% to 25% margin to minimize the friction on the initial sale because we know we have you for 8 to 10 years. So hardware is really just an enabler for SaaS in some respects. But the way we look at hardware is how we've kind of evolved over the last couple of years. We actually came out with the interactive security system based on cellular modules that we developed, so a cellular-based system. We've now been licensing that technology to the control panel manufacturers. And so before, we used to sell millions of dollars of cellular modules. We don't sell those anymore. So that's actually affected our hardware revenue, which is fine. We're fine not selling that because we want to reduce the up-front cost for the subscriber to get assistance. And then when we think about like on the enterprise segment, the enterprise and large businesses actually have a higher penetration of security systems than residential. About 50% of businesses have a security system. Most of those are legacy systems that are not cellular based, that are landline. And so what we've done is we've actually now integrated with a number of other camera manufacturers for the enterprise so that when our enterprise group goes in to make a sale to a let's say large franchisor, many of those cameras can be retained, meaning we have fewer hardware sales, which we're fine. We get that recurring fast so that's the way we look at hardware. And I really encourage investors to not look at hardware. Look at the SaaS revenue and the Saas revenue growth. That's really the leading indicator of our business. And let's face it, hardware doesn't have a high valuation right, 1x revenue. But the recurring SaaS that we have that's highly predictable has a high degree of value.

Yes. Agreed. Agreed. Of course, both those things really filter down to again the EBITDA generation that we've seen despite headwinds, right, whether it's Vivint, whether it's litigation costs right? So I want to touch on that a little bit. I called out sort of the roughly similar EBITDA dollars year-over-year, right, despite some of those events. Part of the success there, I think, was just driven by -- I think Stephen Trundle calls it some recent belt tightening, right?

That's right. Right yes, we did do that.

Maybe can you just maybe walk us through the sort of high-level exercise that Alarm.com went through there? And more importantly, how are you thinking about EBITDA margins going forward?

Yes. So a very good point about Vivint, who the history there, they were a service provider back in 2013. They violated their dealer agreement, came up with their own system, only dealer that's been able to do that in the last 10 years. ADT hasn't done it yet, by the way. So what we did was we agreed with them that we would not sue them, we would license our technology to them but we had 200 patents and now we have 600 patents. September of last year, all of a sudden, they then announced that they were going to stop paying a license fee which was about $6 million of revenue a quarter that went right to the bottom line. And so that's $24 million a year that's come off the bottom line. As Saket mentioned, even as a result of that, we actually took some actions to reduce some costs because we do have a lot of leverage in the business. Let's face it, 75% of our costs are people, right? So we made some reductions. We deferred some salary increases. And we were able to have the same amount of EBITDA in the third quarter this year as we did a year ago, when a year ago, we had $6 million more profitability. So we've been able to move quickly. And I think that shows the leverage in the business, how quickly we can rebound and get that EBITDA back up. And in the past, we've been able to generate 20% EBITDA margins. When we went public, we gave a goal of 20%, 25%. Recently, it's been 16% to 18%. Steve Trundle's recently said our goal in the near term is 18% EBITDA margins. But that's investing 28% to 30% of our revenue in R&D. At some point in the future, that has to come down, right? And so at some point in the future, we should be able to have 25% to 30% EBITDA margin. Now, I'm not saying that that's going to happen in the next 5 years or it's going to happen in the next 10 years, but it shows the leverage in the business. There's a lot of leverage in our model.

Right. Right. Well, I couldn't think of a better point to end on there. Steve, thank you so much for the time. Really appreciate you making the trip here.

Thank you for having us.

Enjoyed it.

Thank you.