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

All right. Good morning, everyone. Cory Carpenter, Internet Analyst at JPMorgan. Pleased to have Steve from Alarm.com. Thank you for joining us this year.

Great to be here.

So for those newer to the story, I thought we could start with a high-level overview of the business. And just how Alarm has evolved over the years?

Sure. Yes. First of all, just to give you some background of Alarm.com. So what we do is we provide the operating system for smart properties for both residential and commercial. And we've expanded over the years to energy to multifamily dwellings as well apartment houses. And just to give you some background, so we started back in 2000, with really looking at the security system and realizing that the security system was a landline based system that had basically very limited capabilities. And if somebody actually cut your line, you would not have a security system. And so we developed an interactive security system, cellular based. We actually invented the cellular module so that you could actually use your security system, not just when you're in the home, but also when you're out of the home with your smart device. So you could use your iPad, your iPhone, and you can actually turn off and on your alarm system. And then, of course, we came out with video and video analytics, which really changed the security system quite a bit. It made it much more interactive. And in fact, we have subscribers who use a security system to see what -- when their children come home from school to see what animals are around their property, and so all kinds of fun use cases. And so we've really evolved the system quite a bit over the years, and we've been the leader in the market for a long time, having been the innovator in the security system. And again, it's not just a security system. It's an actual smart property, smart devices. So we integrate with a lot of different third-party devices like Lutron likes, like your door locks, like your garage or openers. The whole vision we have here is we should be managing and helping you manage everything around your home and even outside of your home. With AI, we've expanded the use cases in terms of providing smart alerts and all kinds of capabilities. So our vision for the future is every property should be a property that's covered by Alarm.com and have the capabilities of AI and the video capabilities and expanding it, again, not just in your home, but in the business and also your vehicles, which we'll talk about a little bit later.

Great. Good overview. So how do you think about the addressable market for your core residential security business in the U.S. Could you just level set for the audience, the growth and penetration levels of the industry today?

Sure. So there's about 140 million homes in North America. About 30 million of them have professionally monitored security, meaning that there is some central station or a call center that's actually monitoring the property. Of those $30 million, about half of them are interactive. And again, the distinction with interactive means that you can use your smart device outside of the home or even inside of the home and turn off and on your alarm and you could actually see what's happening in video. Believe it or not, there's still -- half of those 30 million have legacy systems that are landline based that are not interactive, which is surprising in this day and age. But of the 30 million homes, again, that have monitor security, about half of those are interactive. We only provide really just the interactive. That's our focus. That's a growth opportunity. About half of the 30 million homes, again, have that interactive. Half of that -- more than half of that market is Alarm.com subscribers.

Great. So a lot of companies this week have talked about macro pressure across consumers, across SMBs. How is the macro environment impacting you? And then more broadly, just could you talk about the cyclicality of the business?

Sure. The good thing about the business is, is countercyclical to some extent, when there's fewer moves, there's higher retention. The #1 reason for churn is actually moves. So with fewer people moving, fewer new homes and it really reduces the churn. And so we reported last quarter, retention rates of 94% net retention, which is at the higher end of our historical range. So that's good. We also reported about 11% SaaS growth year-over-year, so respectable growth. That said, I would say that on the residential side, we're seeing subscribers maybe take on less cameras, trying to save some money. So a little bit less in terms of hardware sales, which we're okay with because we'll talk about a little bit later. Hardware has really been an enabler for SaaS. It's a lower-margin part of our business. On the commercial side, so we have SMB, which is a small business, of course, and then we have large enterprises. On the large enterprises, we are seeing a little bit of a slower uptake. The pipeline is still very strong. Large enterprises like retailers, like commercial properties are taking a little bit longer to roll out. And so we've seen some effect there possibly because of higher interest rates, just being more cautious about the economy, but we're still seeing very good growth in commercial.

So let's talk about that -- those margin profiles. So I think one of the differentiating factors from our perspective between Alarm.com and other smart home companies is that you primarily monetize through SaaS revenue and not hardware. Could you talk about your go-to-market strategy and just the competitive advantage that provides you?

Sure. So what Alarm.com does is, again, we host a SaaS operating system for smart properties. So our service providers, these are independent business and we have over 12,000 service providers out there. They're focused on doing the installation, doing the monitoring, doing the servicing, doing the renewals. We provide the R&D engine, if you will, for that service provider. We basically make sure that we provide all the third-party integrations, we develop all the technology, and we host this technology in the cloud. So that's very expensive, as you can imagine. And so it's a huge competitive advantage and a huge barrier to entry for others to try to do what Alarm.com has developed over the last 20 years. So SaaS being our focus, about 2/3 of our business, our revenue is SaaS recurring revenue. About 1/3 is hardware. SaaS has about 85% to 86% gross margin. That's really our focus. Hardware is simply an enabler for SaaS, and we've actually priced the hardware as low as possible so that we can drive more SaaS revenue. And in fact, we don't provide all of the hardware components of a typical security system. The typical security system has a control panel. Those are made by third parties. While we also have the cellular connector, the radio module, we've licensed that out now to third-party providers. Again, our goal is to minimize the upfront cost for the subscriber, so they become a subscriber of Alarm.com. And once they do for a residential customer, the typical life is 8 to 10 years. So we have high recurring revenue, high LTV to CAC because our CAC is very low. We rely upon the service provider. Again, they're mainly doing the CAC. They're doing the customer acquisition. They're spending the marketing money. We don't spend much money on marketing.

Could you talk a bit about your relationship with those 12,000 service providers? Just how does your pricing model work? Why do they choose to work with Alarm?

Yes. So the 12,000 service providers really look to Alarm.com, again, for the R&D engine that we provide. And the way we price on a residential basis is if you think about a residential end customer, they're paying a service provider anywhere from $45 to $75 a month for the subscription. We charge a service provider based upon the plan that the end customer has. It's like a cell phone plan, the more features you have, the more we charge the service provider. In a typical system, let's say, an entry-level system, we might charge the service provider $5 or $5.50 per month on average. For a higher-end system, which includes video, video analytics, thermostats and third-party integrations, we made charge $8 to $9 per month to that service provider. And of course, they would charge more to the end customer. That's residential. Now commercial has a higher ARPU. And Commercial has an ARPU where we charge a service provider 2 to 6x more than the residential customer based upon the number of cameras, based upon the number of devices. The service provider we charge the commercial customer anywhere from $100 plus per month. And so there's quite a bit of difference in terms of the commercial versus residential. From a development point of view, the systems are somewhat similar, but there are some different AI use cases for each, as you can imagine.

Could you -- how much of those prices changed over time? Or could you just talk about the pricing power you have? And is that a lever you often pull on for growth?

So from a pricing point of view, Alarm.com strategy, at least on the SaaS, has been to introduce new feature sets. So we came out with video back in 2017 or '18. We came out with video analytics shortly after that. And we charged more for the service provider, and that allowed the service provider to charge more to the end subscriber. So we haven't really pushed the envelope, if you will, on pricing on the SaaS side of the business. Now recently, we have provided modest increases, very modest increases on the SaaS pricing for the first time in the company's history. Again, it's very modest, below inflation rates. On the hardware side, we did increase prices a few times in 2022 based upon all the supply chain dynamics and everything that was going on in the cost increases and inflation. But our strategy really has been on the SaaS side to be able to provide more tools and more services for the service provider for them to charge more. So over time, the service provider has been able to charge more to the end subscribers based on the feature sets. And so we've been able to charge more, too, and that's enabled our ARPU to go up. But again, given our relationship with the service providers, we've not taken advantage of that and just passed on price increases on just a recurring basis, we've been very cautious on that front because we realize that's an important relationship. It's a big ticket item for them, and we don't want to take advantage of the relationship, if you will.

So kind of one more bigger picture question, and we'll get into your growth initiatives. I wanted to ask about the competitive environment. Who else is competing for Service Pro budgets? And then how do you think about the DIY as a competitor?

Yes. But it's definitely a competitive industry and there -- it's interesting when you think about DIY and you think about the professional install market. In terms of the professional install, I would say Resideo is our main competitor there. They were spun out of Honeywell, what's been about 3 or 4 years now. They're also looking to sign up service providers. They're more known for hardware. Alarm.com is known more for SaaS and our software, which we think has a big advantage, given all the AI capabilities that we built up over the years. On the DIY front, there are competitors mostly on the hardware side. So Ring was acquired by Amazon. Ring has done a good job with the doorbell. So in some cases, our service providers will go to homes and the subscriber wants -- or has a ring doorbell but they still want an Alarm.com security system. So there's a misnomer, thinking that it's either DIY, professionally install. And in fact, they're not mutually exclusive, they can coexist. In some cases, they do coexist. But again, I think it's more of an impact on the hardware side. And in fact, we've guided hardware down slightly this year over last year mainly because there are fewer cameras being installed and there are these other options out there. Again, we're okay with that. Our focus is really on the recurring SaaS revenue.

So moving to some of your growth initiatives, which now account for just over 30% of SaaS revenue, growing mid-20% year-over-year pretty consistently for a while. Starting with commercial, which you've mentioned a few times, how big is this business for you? And how do you think about the market opportunity relative to residential?

Yes. We think the TAM for commercial in North America is 5 million to 6 million properties. The commercial SaaS is growing over 30% year-over-year, and it's about 10% of our total SaaS. A year ago, it was 8.5% or so. So we do see a significant opportunity in commercial. And again, commercial is made up of SMB, which is really provided by our service providers, the 12,000-plus service providers. And then for the Enterprise Commercial segment, those are integrators that are selling to large retailers, franchisees, large universities, Gonzaga University is a customer of ours, of course. And they're going to these large organizations and basically selling a fire suppression, energy management, all kinds of different things, and they bring in Alarm.com for the security system for their commercial enterprise. And you can imagine, given all the -- the world is not getting any safer, let's face it. And so we think that there's a significant opportunity for commercials, especially given all the capabilities that we've been providing and all the feature sets that we've added over the last couple of years for commercial.

Let's move to international. What does your presence look like outside the U.S. today? And what are some of the challenges to scaling relative to the U.S.?

So we're in about 60 different countries today. We have about -- of our total revenue, 5% is international. A year ago, it was 4%. So it is growing. 5% is too low, we think. It should be 20% to 25% of our revenue or larger. There are some complexities in international. So each geography, you have to work with a different cellular carrier. There are some different standards. You have to work with different control panel manufacturers. So it does take more time but I would say we've made good progress in international. We're not at that inflection point where we were with residential. In 2012, '13, where all of a sudden, we went from 1 million subscribers to 2 million subscribers. We're not there yet. But we're continuing to make good progress in international, and we should still -- we should continue to see international grow. But there definitely is -- there are definitely more headwinds than there was in North American residential. So it's taking a little bit longer than we grew as we grew North American Residential.

So I'll leave the growth initiatives [indiscernible] question. Just what else would you highlight across, whether ObjectVideo, EnergyHub or some of the newer initiatives you talked about in earnings?

Yes. We're very excited about AI, and I know everybody is talking about AI today. So we actually started talking about AI back in 2017 and '18. When we acquired ObjectVideo out of Reston, Virginia, that was doing a lot of work for the government, we took those [indiscernible] and video analytics and directed them to video and video analytics. So now we have smart alerts that we provide for residential customers. We can detect animals, vehicles or persons. And the AI capabilities that we've developed have expanded now. So we've just recently announced familiar vehicle. So if you have a car that pulls in your driveway, and you've identified that as being your kid's car or someone else's car that you know, you don't have to set an alert or you can set an alert. But if all of a sudden, some strange vehicle posing a driver, you'll get an alert, and that will alert you, of course, that maybe there's something not right going on there. For commercial, we've done line counting. We've been able to provide like alerts about someone loitering around the property. And so it's made it very helpful for commercial property owners to be able to figure out if there's something bad occurring. Also, we acquired a company in Spain, Vintra, that actually has some interesting technology for our large enterprise customers. You can imagine if an enterprise -- some of our enterprise customers have hundreds if not thousands of cameras. And if there's a bad actor, that's a lot of video to go through. Well, this technology can actually classify a person and track that person wherever they've gone in the location, and that will help to identify that bad actor and hopefully resolve that before that bad actor actually acts bad.

So sticking on AI. So some examples you gave of how you're leveraging it today. How do you -- where do you see that going? What type of opportunities do you think this technology could open up for you?