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

Thank you all for joining us today at the BofA Technology Conference for 2024. I'm Mike Funk, one of the SMID Cap software analyst. Very pleased to have Steve Valenzuela with us again from Alarm.com. If you don't know Alarm.com, it is one of the leading innovative technology companies with the operating system for the connected property. Go-to-market is primarily through, I believe it's about 120,000 service partners out of the marketplace, servicing both the residential and the business customers. And if you're not familiar, a lot of good material on the website, they always have updated presentations. But I do want to invite Steve first maybe kind of set the ground for us here, maybe some more details on the company and the recent performance.

Yes, sure. First of all, it's great to be here. Thanks for having us. It's always a great conference. So Alarm.com was started in 2000, really with the idea of taking the security system that was landline based. And if you cut the wire, you would have no security system. So the company came up with a number of innovations really to make it cellular-based, and then we were one of the first apps on the App Store for Apple, but we made the security system interactive, so you could actually use your smart device outside of your home, inside of your home instead of just coming home in the playing security system where you plug in your code and you activate or deactivate. And around 2011 or '12, we got to 1 million subscribers. And then the next year, we got the 2 million, and we've grown up since then, and we've expanded from North American residential was our starting point, to commercial, to international, and we've added much more feature sets and we've actually expanded the offering to include energy, multifamily, apartment houses. And so the idea is really that Alarm.com focuses on innovation in terms of technology, the service provider, where we have over 12,000 service providers, they're really focused on the customer acquisition, the marketing, actually servicing the customer, actually installing the security system, managing the security system. And when there is an alarm, it's not Alarm.com that responds, the service provider uses our software to see what's happening around the property and dispatch 911 or first responder if it's needed. So over the years, we've grown a lot. I mean, when I joined the company about 7.5 years ago, we had about $260 million in revenue, about $25 million adjusted EBITDA. This year, we've guided for over $900 million in revenue. So we've had good growth. I think that's a CAGR of over 20%-some and over $160 million of adjusted EBITDA we've guided to this year, actually about $165 million at the midpoint. So good growth. We've done about 14 acquisitions in the last 7 years and we've been pretty acquisitive. Most of those have been small to medium-sized companies. Some have been more technology aqui-hires where we've added some technology and we've added different functions. We've also expanded the services through the acquisitions, and we were one of the early innovators of using AI in the security system, which I'm sure we'll talk about. So that's probably a good overview, I would think.

It's a great overview. Thank you, Steve. And yes, I want to start with maybe a higher-level question everyone cares about today is characterized in the macro environment today versus maybe 6 or 12 months ago. We have heard from software companies this last quarter that service more of the enterprise that perhaps they were feeling more macro pressure last quarter. Obviously, your customer, your end market is very different than that, but framing the macro would be helpful.

Yes. So we reported our Q1 results. We saw solid growth with our SaaS revenue growing 11% year-over-year. So we're seeing good subscriber additions. We're seeing actually good EBITDA we reported in the quarter. I would say on the hardware side, where hardware is about 1/3 of our revenue, that's a little bit hard to predict because it's not recurring. And typically, what we see sometimes in a challenging environment, customers may buy fewer cameras instead of 4 cameras, they might buy 2. On the commercial side as well, we've seen where some of the large commercial customers have deployed fewer cameras or they're deploying at a slower rate. But overall, we're still seeing very good growth. The other thing that's really interesting about the business is that it's somewhat countercyclical. We've seen very good retention. So our dollar retention has been 94%. That's at the higher end of our range. And part of that is there's fewer moves and moves accounts for the #1 reason for attrition. So it kind of helps after fewer moves. There may be less new subscribers, but then that actually helps to offset that. So that tends to be somewhat countercyclical from that point of view. The other fact too is the world is not getting any safer. So both residential and commercial customers look at the environment around them. And typically, when we have challenging environments or it looks like there's -- the economy is not performing as well, there's more people out of jobs, and then people tend to want to keep their security system. And when you think about the security system for like a residential customer, they might be paying the service provider anywhere from $45 to $75 a month, and they've invested thousands of dollars in their cameras. They're not going to cut the cord. Most of those are under 3- to 5-year subscription agreements anyway versus a streaming service like YouTube TV, you can easily cut at $75 a month. I think service is much more important -- security is much more important to have than a streaming service. So it's very highly predictable, highly reoccurring and high renewal rates. It's like the gift that keeps on getting I'd like to say.

It's a great point, Steve. And you touched earlier on AI, over last year, sitting here with you, we just finished doing our big AI primer and talking about companies that had opportunity in AI. And I was really struck by the comment that you made that you really had a tangible monetization opportunity with AI, which most software companies today have articulated that opportunity as well as you have. So maybe remind us where the opportunity is for Alarm.com. And if you have the product road map going forward?

Yes, we certainly do. And in fact, we were an early innovator in AI. If you look at back in 2017, we acquired a company in Reston, Virginia, ObjectVideo, that was doing a lot of AI work for the government. We took that team of PhDs in video analytics and repurposed them to look at security systems and we've set in millions and millions of clips into our system, into our neural networking. We came out with our AI system were residential right around the end of 2018. And so what that did actually was to make the security system very smart, so it actually will give you smart alerts. And you could characterize or customize whatever the alerts you want, but it's like being able to detect person vehicle and animals. And you could even use it to detect is your family coming off from school, when are your kids coming off from school. So that's where residential. We've expanded it now to be able to do more for commercial as well. So both for SMB as well as for large enterprises, there's a number of features that's like LAN counting. LAN counting that is where if you have like multiple different restaurants in a location or coffee shops and you can get smart alerts as the owner telling you that one shop has a longer line, longer wait than the other one, you can dispatch your employees to that location. So that's something we came out with. About 1.5 years ago, we acquired a company in Spain, Vintra, that actually had some really interesting technology we thought for commercial, especially for large commercial enterprises where you might have hundreds of thousands of cameras and if you have potentially a bad actor, how do you track all that and how do you classify that one potential individual and see where they've gone throughout the establishment. So they have technology that we've now deployed in our commercial solution that actually tracks and can identify that person without using facial recognition because there's some negative connotations of facial recognition, but they classify that person. And then that security officer can track that person across thousands of cameras. So we think that's pretty innovative technology. And we have a number of new innovations coming out. We have a full team that's focused on AI, a number of PhDs and engineers that are really focused on new various different innovations in AI. I won't name all of them because we don't want the competition to know about them. But we are continuing to innovate here and coming up with new solutions, both for residential as well as for commercial.

And can you frame the revenue opportunity from AI, maybe whether it's residential or commercial separately? And then if you can even talk about the attach rate of AI. And I presume that is in-part and tangent upon penetration of video with a lot of the solutions being video and handset, correct?

Yes, so that's right. So for AI for residential, give you a sense of kind of our ARPU versus the service provider. So for residential, for a base system, we might charge a service provider $5.75 a month, they would charge the end subscriber, let's say, $45 a month or $50 a month. If you have video and AI, so we charge separately for video, additional for video and additional for AI. So a subscriber, a residential subscriber that has AI system with video, we would be charging the service provider more like $650 to $850 a month. They would be charging the end subscriber more like $65 to $75 a month. But we actually charge more for AI. And the attachment rate, so for video, the attachment rate is about 50% which I'm surprised it's not 75% or 80%. But I guess there are some subscribers who are still not adapting to video. But I think over time, that will increase. But the attachment rate for those who have video that get AIs 99%. So in other words, when subscribers get video, almost all of them get AI. So we get the higher ARPU as a result of that. That's residential. On the commercial side, we also charge more for AI. The attachment rate there is probably a little bit less on AI because it's still new. The interesting thing about commercial is there is a higher penetration of security systems for commercial customers, but most of those are the old plan landline-based systems where you don't have the interactive capability. So we're going in and obviously, in the commercial establishments and replacing those systems with Alarm.com, our service providers are doing that and putting in the AI-enabled interactive security system where the business owner can see what's happening around their property, as we talked about. Also, we have access control for commercial. So there's a lot of AI technology that we've deployed both for residential and commercial, and that actually increases our ARPU overall and increases the SaaS recurring revenue.

And why do you think the video attach rate is 50% of residential and not the 70%, 75% you mentioned earlier. Is that going back to the macro comment or is there something else that causes that resistance in residential?

Yes, it's a good question. It's hard to say. It might be a little bit of both actually, because we try to price the cameras as low as possible. So we don't make much of a margin on hardware. Our hardware margin is about 20% to 25%. Our SaaS recurring margin is 85% to 86%. So the pricing of cameras is not that high. But when you add 4 or 5 cameras, you're talking potentially thousands of dollars. And so it could be related to initially getting a system and not wanting to spend the upfront costs as much of the upfront cost. It may also be that, to be fair, it may also be that the subscriber in some cases where our service providers go into home, the subscriber might have a different doorbell in Alarm.com where they might have a camera that they're using, and they want to continue using those other cameras, DIY cameras, but they want a complete security system from Alarm.com. And so that may be as well. But we think over time, as we continue to innovate with AI, continue to provide the feature sets and expand the feature sets, we think that video attachment will increase for sure.

And I wanted to touch on DIY. You just mentioned it there. And I can't remember the exact stats, but I mean I think DIY now accounts 40% plus of home security of I think, from 10% or 15% 4 or 5 years ago maybe slightly off, but the magnitude I think is about.

It's really hard to say because there's various different thoughts out there, opinions. Let's say somebody has a video doorbell, right? Is that a fold, it's not a complete system. So what you find is like in apartment houses, you tend to see more DIY, which makes sense, right? So you have an apartment, you may want a video doorbell, you may want to have 1 camera, but it's not a complete security system. So it is a little bit of apples and oranges comparisons.

But are you still seeing a segmentation in the market, though, where I mean I think generally, it was the kind of the higher-end consumer, the middle income consumer, one of the full monitored security solution that Alarm.com would support and maybe DIY was more attractive or appealing to other segments of the iconic. Is that still true today or is that shifting.

I think it's still true today. If you think about the -- our subscriber for residential typically is a middle to upper income homeowner mostly. They may have a vacation property as well that they have secured. And whereas DIY, again, it may be more -- like when I talk to some folks, like investors who have apartments, they tend to have DIY, maybe a camera or 2. So I think there is still that segmentation. Of course, there are some DIYs out there that want to spend their weekends on their home and actually climb ladders to put up cameras. I don't know many of those. So I think that segmentation is still there. And so I think that what we see too is that people will progress from DIY to a complete security system. So they may initially put in a doorbell from another provider and then they realize there's something happening in their neighborhood, and they want to get a complete security system and they reach out to one of our service providers to have a complete security system installed, but they may still want to keep that doorbell.

That's a great point, Steve. And I think a lot of investors characterize Alarm.com as a very predictable revenue growth, high-margin dominant market share company in respective industry, but maybe overlooked the growth opportunity internationally, but international being much lower penetration or professional monitoring. And so maybe bring us up to speed on the progress internationally and where you see the opportunity?

Yes. So international now is about 5% of our revenue. A year ago, I think it was about 4%. So it's still less than 10%. However, it's growing over 20% year-over-year. I think now we're in about 70 different countries. We have a number of opportunities in Asia. We're expanding in Europe, South America. And so we do see quite a few opportunities internationally. Part of that is that there are different competitors internationally different providers. But again, most of the incumbents are Plano security systems, where it's not interactive. And so these providers, service providers are looking at Alarm.com in a make versus buy situation where do they want to spend the money to try to invent an interactive security system or they want to partner with Alarm.com where we would actually come in and then we would provide them the technology, we would host the subscribers like we do for the U.S. customers, and they can quickly retrofit their existing subscriber base and get a quick uplift. And the reason they would do that is because if they don't change the interactive, they will lose those subscribers to other competitors. And so it really is a greenfield opportunity. We think international, at some point, can't say if it's going to be 5 years or sooner, should be 25% to 30% of our revenue.

And are you ramping up your efforts to sign more partners internationally? Are you changing anything there?

Absolutely. Yes. We definitely are making an investment in international. So actually, we acquired a company, EBS in Poland about 1.5 years ago. They have some technology, mostly hardware technology communicator that we're going to be coming out with very soon actually, that's going to allow us to get into more countries internationally at a lower cost and actually enable the configurations to be adapted quicker. One of the challenges in international is each country has different control panels. We don't make the control panel that's part of the security system. They're made by third-party providers. So we need to interact with those control panels, and then also there's different cellular providers. So EBS, the acquisition we did, again, about 1.5 years ago, is going to allow us, enable us to be able to, we think, penetrate international various different countries faster than we have in the past.

And I wanted to shift topics here a little bit, Steve. Last quarter, you mentioned the move into fleet management. I think Connected Fleet was a product that you talked about last quarter. I was a little surprised by that. It seemed a little maybe outside of your historic wheelhouse, relatively fragmented market with fleet monitoring and management. Can you walk us through the thought process and the analysis that went into deciding to enter that market?

Yes. Part of it is we get feedback from our service providers. So it's interesting on the Connected Fleet, one of our customers, of course, would be the service provider because they have fleets. And so it is a fragmented market. It's not something that we're including in our guidance. It's not something that we're expecting to have initially a big uplift in revenue. It's more adding more feature set, if you will, to our app. So if you think about it, like I have 6 different pages of apps in my phone trying to find the app sometimes it's not easy. So part of our strategy is to have as many features in one app as possible. So with an Alarm.com app, you can actually see your security system, you can see your cameras, you can see your cars with the car adapter we have. And now as a business owner, you can see your Connected Fleet, you can see where your employees are. So it's again having that ease of use and then allowing our commercial service providers not only to use it for themselves, but also sell it to their subscribers and their customers, HVAC customers or different commercial customers. And so that's part of our strategy has been to expand Alarm.com. Initially, we started North American residential. Then we added commercial and we added international and now we added energy and now we've added Connected Fleet. And so it's, again, providing the Alarm.com not just inside the home but outside the home and around the area as well.

So is the plan or thought then since you think so many could be existing customers that the customer acquisition cost will be relatively low for connected fleet? And if so, I mean, how do you envision the customer acquisition cost as you move into that new market?

Yes. I would say it's too early. I would probably downplay Connected Fleet now. I don't want to set expectations too much. Like you said, it's a fragmented market. It's something that's not in our guidance. We're going to see how that goes. We're not, let's say, making a huge investment in that area just yet. We want to see how the uptake occurs. Typically, when we come out with a new solution, it does take time as the service providers have to be trained on it. The beautiful thing about Alarm.com is we have 12,000 service providers, and they have many, many salespeople out there every day selling Alarm.com, installing Alarm.com, but it also means that we have to have all these folks trained. And so when we come up with a new feature set or new service, it takes longer for the uptake. So I would downplay connected fleet for now. I think it's a nice new offering. We'll see how it actually gets attached. But for right now, we're not including in our guidance, and we're being cautious to make sure that we don't set expectation there that's going to be a large revenue driver. We'll be surprised if it is, but for now, it's simply another feature set that our service providers can use and can sell.

Understood. That's very clear. I wasn't sure after last call. Now I'm very clear on what the strategy is on that. That's helpful. Another question we get a lot has been hanging out there for years, is the ADT situation. It's been to fear that they might start to peel away some of the subscribers based on their new partnership with a large technology company. Can you just tell us or remind us where we are in that process and then your view of the competitive threat?

Yes. ADT is a very good customer of ours. Just to give everybody a little bit of background, ADT became a customer of Alarm.com when we acquired Icontrol, the Connect portion of Icontrol actually based in Redwood City here back in 2017. So that got us a relationship with ADT. They were working with Icontrol for a Pulse application, which is an interactive solution, but not as interactive as Alarm.com. And so ADT was supportive of Alarm.com acquiring Icontrol because Alarm was ahead of Icontrol. So we work with ADT after that acquisition. We continue to actually support the Pulse application for ADT, which is a legacy system. And then we work with ADT using Alarm.com's software to come out with ADT kinetic control, which is Alarm.com that we actually owe the subscribers, we actually managed that software for and ADT now has millions of subscribers on that solution. And so they've been very happy with Alarm.com. We got a very good relationship there. But what happened in August of 2020, Google invested $0.5 billion in ADT. A little bit of history of Google as they acquired Nest about, I think, 8 years ago, based in Silicon Valley, they paid many billions of dollars for Nest and there's been a history there where Nest has not really worked very well. But I think Google is looking at how do they get more devices in the home and compete with Amazon Alexa. And so I think as part of that relationship with ADT and Google, ADT announced that they would be coming out with their solution at some point in the future, what they call ADT+. Again, that was back in August of 2020. I think in the last earnings call, ADT publicly discussed that they've started to roll-out some of the solutions, a small amount of solutions of this ADP+. Part of the agreement we have with ADT is that Alarm.com will continue to operate the existing subscribers on command and control ADT for their natural life. And so we would continue to have subscribers for ADT for at least 8 to 10 years. And if they're -- when ADT does come out with their new solution, they would then pay us a license fee or every new subscriber they put on that service what they call ADT+. But again, we also will continue -- we believe ADT will continue to have -- use Alarm.com for high-end home for custom homebuilders, for commercial. And so while we have factored into our guidance that ADT would start to transition new subscribers beginning in the third quarter of this year to their new solution, we put that into our guidance, we factor that in. But again, it's the existing subscribers will stay on for a long time.

And to your point, churn rates are incredibly low, and the home monitoring business monitoring marketplace, you're talking about 10, 15-year potential lifetime to describe this. So even if there could be degradation in the subbase, it would be a very long cycle.

Yes, exactly. And again, it just shows you how difficult it is what Alarm.com does, ADT analysis, Google relationship almost 4 years ago, and it still hasn't been widely deployed. So it's not easy, what a lot…

[indiscernible] questions. I apologize, but I talk with a lot with investors. I wanted to get it out there. Even more in your wheelhouse, and you mentioned earlier as well, is the M&A strategy and how you've done a number of bolt-ons over the years. So Steve, how should we think about capital allocation? And then specifically, M&A, where there may be opportunity to enhance the offering, accelerate growth, move into new markets?

Yes. So we've definitely done a number of acquisitions where we've either done to acqui-hires, where we get the technology like Vintra, a feature set like EBS in Poland. And so we do have an active business development team that is looking at various different opportunities. We're pretty selective. We want to make sure there's a cultural fit. We want to make sure it's going to be something that's going to be able to bolt-on to existing solutions that we have, either our service providers will be able to resell it or there's some value-add there that we can actually deploy. And so M&A is definitely part of our strategy. Another part of our capital allocation has been share buybacks. We have over the last couple of years, bought back over $100 million of our shares. As part of our recent convertible we did last week, we actually bought back about $75 million of those shares related to that convertible that was part of the convertible structure. And then the Board authorized another $100 million of share buyback on top of that. So share buybacks as part of the capital allocation strategy. And then we like having a good amount of cash. Of course, we're investing that cash today, 5% plus. But the goal is not to just keep it in the bank. The goal is hopefully to be able to deploy it, if we find the right acquisitions that are going to add a lot of value to the company. And they could be smaller acquisitions, they could be medium to larger acquisitions, but we're pretty selective. We want to make sure that, again, that it's the right fit for the company.

That's perfect, Steve. And same line here, for a very predictable revenue growth, high-margin business, what's your view on the right amount of leverage for the business? And could we potentially over time with predictable growth, maybe slower growing market as we mature, see incremental returns to shareholders beyond the share repurchase?

Yes. Today, we're investing, I would say, in R&D, 28% to 30% of our revenue, which would be fair is a high amount, probably the high watermark right now because we see all these different opportunities, and we publicly said Steve Trundle, our CEO, has said that 18% EBITDA margin is the target for right now. And so if we look at that, given all the different investment opportunities, it makes sense today, but I would say at some point, there certainly is a lot of opportunity for leverage in the business at some point. I can't say when that would be. If you look at the history of the company, before the company went public or even in early days, the EBITDA was quite a bit higher than what it is today. And so we've invested in all these different areas. And certainly, at some point, it certainly would make sense for the R&D investment as a percent of revenue. It would not be 28% to 30%, but I can't say when that would be. And if that comes down, it would come to the bottom line and EBITDA would increase. But for today, it's 18% as our EBITDA target going forward.

I think you just mentioned the convert. What was the thought process behind issuing the convert versus, say, issuing straight debt? I'm sure you probably went through many iterations. How you thought about that? What was that thought process.

Yes. Well, a couple of things. One is we did look at straight debt. Straight debt is going to be a coupon of 7% to 8%. And the converter was 2.25%. The other thought process too is we have an existing convert that we put in January 2021, that is a 0 coupon that is going to mature in about 1.5 years from now. So we're going to have to retire that coupon. And so that's part of the thought. And also just taking advantage of the convert market is very attractive these days. We didn't get a 0 coupon, but 2.25% in the meantime, where we're investing that money at 5% until we -- if we find the right opportunity. So we felt that the convert was a reasonable way to go and…

Or a very attractive coupon to your point.

It is a very attractive coupon. And there is some dilution. But again, we did buy back shares as part of that convertible. So we retired about 1.1 million shares. There are some shares that were on an as-converted basis when you do a convertible, you have to include in your equity, in your share count, but that goes away once the convert is paid off. It's a 5-year convert, right? So net-net, there is a little bit of extra dilution there, but we feel it was the right thing to do compared to trying to do a follow-on offering, which would have been dilutive or to do straight debt, which would have been at a very high coupon rate.

Absolutely. I think we're actually about out of time. That went quicker than I thought. But Steve, thank you so much again for the time. We really appreciate you being here.

Thanks for having me. Thank you.

Of course. Thank you.