All right. Good morning, everyone. Corey Carpenter, internet analyst, JPM organ. 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.com evolved over the years.
Sure. Yeah, 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 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 the security system to see what. You know, 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, you know, having been the innovator in this, in the security system. And again, it's not just a security system, it's a actual, smart property, smart devices.
So we integrate with a lot of different third-party devices, like Lutron lights, like your door locks, like your garage door 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.? And 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's some central station or 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 monitored security, about half of those are interactive. We only provide really just the interactive. That's our focus. That's the 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's 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 it's countercyclical to some extent. When there's fewer moves, there's higher retention. The number one reason for churn is actually moves. So with fewer people moving, fewer new homes, you know, 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, you know, hardware sales, which we're okay with, because we'll talk about a little bit later, hardware is really an enabler for SaaS. It's a lower margin part of our business.
On the commercial side, so we have SMB, which is 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, so 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 two-thirds of our business, our revenue is SaaS recurring revenue, about one-third is hardware.
SaaS has about 85%-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. We also have the cellular connector, and 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 eight to 10 years. So we have high recurring revenue, high LTV to CAC, 'cause 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?
Yep. 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, you know, residential end customer, they're paying a service provider anywhere from $45-$75 a month for the subscription. We charge the 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 might charge $8-$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. Commercial has an ARPU where we charge the service provider two to six times more than the residential customer, based upon the number of cameras, based upon the number of devices. The service provider would charge the commercial customer anywhere from $100+ per month. And so there's quite a bit of, you know, 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.
How much have 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's strategy, at least on the SaaS, has been to introduce new feature sets. So we came out with video back in 2017 or 2018. 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, you know, 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 and 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, you know, just passed on price increases on 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 wanna, you know, take advantage of the relationship, if you will.
Kind of one more bigger picture question, and then we'll get into your growth initiatives. Wanted to ask about the competitive environment. Who else is competing for service pro budgets, and then how do you think about DIY as a competitor?
Yep, it's definitely a competitive industry, and 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 has it been, about three or four 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, you know, AI capabilities that we've 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 or professionally installed, 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, you know, 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, 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?
Yeah, we think the TAM for commercial in North America is 5-6 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, you know, the 12,000+ 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.
They're going to these large, you know, organizations and basically selling them fire suppression, you know, energy management, all kinds of different things, and they bring in Alarm.com for the security system for that commercial enterprise. And you can imagine, given all the, you know, the world is not getting any safer, let's face it. And so, we think that there's a significant opportunity for commercial, 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, and what are some of the challenges to scaling relative to the U.S.?
So we're in about 60 different countries today. Of our total revenue, 5% is international. A year ago, it was 4%, so it is growing. 5% is too low, we think. You know, it should be 20%-25% of our revenue or, 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, you know, in 2012, 2013, where all of a sudden we went from, you know, 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 continue to see international grow. But there definitely are more headwinds than there was in North American residential. So it's taking a little bit longer than, you know, we grew, as we grew North American residential.
So I'll leave the growth initiatives kind of open-ended question. Just what else would you highlight across, whether video, EnergyHub, or some of the newer initiatives you talked about at earnings?
Yeah, we're very excited about AI, and I know everybody's talking about AI today. So we actually started talking about AI back in 2017 and 2018, when we acquired ObjectVideo out of Reston, Virginia, that was doing a lot of work for the government. We took those PhDs in 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 into your driveway and you've identified that as being your kid's car or someone else's car that you know, it'll, 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 pulls in your driveway, you'll get an alert, and that'll 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, you know, 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. You know, 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'll help to identify that bad actor and hopefully resolve that before the bad actor actually acts bad, so.
So sticking on AI, so some examples you gave of how you're leveraging it today, and how do you - where do you see that going? What type of opportunities do you think this technology could open up for you in the future?
Yeah, we think there's a lot more capabilities we can provide for AI. And again, we charge more for AI. So, you know, on a residential customer, we charge at least $1 more per subscriber per month for AI, for commercial, even more, and we think there's a lot more capabilities in AI that we can actually provide a lot more use cases that for both for residential and also for commercial. I'm not gonna get into the details 'cause we don't wanna alert the competition, but we have a full team focused on AI that are video analytics engineers. So we built our own neural network. So our team, back in 2017, 2018, actually fed in millions of clips into our neural network to be able to identify and classify different types of AI events.
And so that neural network has continued to expand with all the different clips that we've been able to feed into it. And so we're gonna continue to expand the use cases. We'll continue to be able to charge more for that, and we think there's, you know, we think there's a lot of opportunity for AI.
So I've got a few more to work through, but we will open Q&A to the audience. So if you have a question, raise your hand, bring the mic, or you can submit it online, and it'll pop up on our iPad right here. So shifting to financials, about two-thirds of your revenue, SaaS, one-third, hardware. We've kind of covered this a little bit, but could you just talk through the different growth trajectories and focus and margins of these two segments?
Yeah. So again, SaaS is, again, two-thirds of our revenue. SaaS gross margin is typically 85%-86%, and it grew 11% year-over-year in Q1, which we reported just a couple of weeks ago. Again, that's our focus. That's the recurring revenue, high LTV to CAC, lifetime value of subscriber, very long, as we talked about, high net retention rates, 94% retention rates. So that's, that's our focus. Hardware is really an enabler for SaaS, but we don't have to provide all the hardware. We're fine with other providers providing hardware.
As a matter of fact, on the commercial side, on the enterprise side, we do integrate with some other cameras, and the reason that's important is because if you've got an existing commercial customer, let's say, who has an investment in cameras, if we can allow that customer to be able to use their existing cameras, they can become a subscriber of Alarm.com faster, and then we get the recurring SaaS revenue. So again, that's what we want. We want that recurring SaaS revenue. On the hardware side, as I talked about, we are seeing, you know, some other use cases where some other customers are providing some cameras or some other components, which we're fine with, and so we did, we did guide down slightly on the hardware side.
The hardware margin is typically 20%-25%, you know, low to mid-20% range, and so again, that's really not the focus. It's again, the focus is on that recurring SaaS.
So just kinda going down the income statement, could you go through your main expense buckets and where you see opportunity for... And maybe kind of talk about your current profitability profile and where you see opportunity for leverage?
So, yeah. So the, again, the focus of Alarm.com is really on R&D. So we are an R&D engine. We have more than half of our 2,000+ employees, I think probably 60% are in R&D. So we're developing capabilities for the service providers to be able to have the best state-of-the-art systems for their subscribers. So we have PhDs, we have engineers in software analytics, we also have engineers who are working on hardware integrations and such, working on AI. And so R&D has been about 28%-30% of our revenue, so that's obviously an oversized investment in R&D we've been making for a number of years. We think that's important, given the opportunities we see. You know, we've expanded again from residential to commercial to international to video analytics to energy management to vacation rental property management.
So we built a diversified revenue stream in our SaaS business, and we think that's important. And so R&D is an investment area for us. In terms of the other areas, sales and marketing has been about 11%-12% of our revenue. We don't spend a ton of money on sales and marketing and marketing. Most of that sales and marketing, if you will, are salespeople who are mostly farmers, who are really, instead of hunters, if you know what I mean by that. They're basically focused on making sure that the service providers are using all of our capabilities, taking advantage of all the AI that we have available, making sure that they're using the newest feature sets that we release, and managing and you know, and meeting with those service providers.
We also spend some marketing dollars on conferences. We were just at ISC West in Las Vegas. I think that was in April. That's really our sales and marketing effort. We're not gonna go out and spend a ton of money on branding, and that's probably why a lot of you don't know about Alarm.com, which maybe we should spend a little bit more money on branding, but we're not gonna spend $25 million-$100 million to get the Alarm.com brand out there. We're really relying upon the service providers to do the marketing through their local, regional subscriber base to get their name out there. So ADT, Brinks, CPI Security, many others are, you know, they're the service providers who are really doing the marketing, doing the customer acquisition.
And with that investment profile, we've been reporting around an 18% EBITDA margin, and Steve Trundle, the CEO, has been pretty clear that that's, that's our focus, 18% margin. I do think that there is a lot of leverage in the model at some point in the future, but we're not ready to talk about that yet. Our focus is really developing, you know, all these feature sets, continuing to expand the opportunity, continuing to invest in R&D, and, you know, with about an 18% EBITDA margin.
Any questions in the audience?
I think you said, retention was 94%-ish.
Yeah.
How has that trended over time? For the 6% that churn, are there big buckets, you know, bankruptcy or moving? I think you mentioned moving on the resi side, that they fall into. Just curious.
Yeah, no, it's a good point. The question is on retention. So, our retention has been 92%-94% over the years, so 94% is at the high end of the range. And I must say, that's a net dollar retention. To be fair, the unit churn is, of course, higher than that, and we don't really disclose that. And then we, of course, have subscribers who are upgrading their systems, so that's why the net retention is 94%. We have more units that might be churning, but then we have subscribers who are upgrading. So 94% net retention, and we really think that, you know, the main driver of churn has really been moves. So it's kinda countercyclical. So, typically, during difficult economic times, you have fewer people moving, and therefore, you have less churn.
And, then you have less subscribers as well. So, you know, we've seen, you know, a good balance, if you will, and typically the business is countercyclical, cyclical, because during bad times, you usually have more crime, and so subscribers are not looking to get rid of their security system. As a matter of fact, if you think about, you're paying, let's say you're paying $75 a month, how much are you paying for your streaming service? You're probably likely gonna cut the cord sooner, or cut the streaming service sooner, because it's easier.
'Cause you made an investment in cameras, you made an investment in security system, so the retention is quite high, and that's why the lifetime value and the recurring nature of the business, what I like to say, is the gift that keeps on giving, the SaaS revenue keeps on coming. So, that's why we like, you know, focusing on our SaaS recurring revenue.
Any other questions?
Can you talk about, the relationship with maybe some of these larger service providers? I don't know if there's, any kind of significant concentration.
Yeah. So, publicly, we've disclosed that ADT is our largest service provider. They're about 15% of our revenue. And then we have, you know, other service providers that, you know, it varies in terms of size. No other service provider is more than 10% of our revenue, but again, we have 12,000 service providers. Some are small, you know, local service providers, some are regional, like Brinks, you know, is more regional as well. The good news about the service providers is they're, again, they're independent businesses, and so we're, you know, we're Switzerland, so we, we provide our solutions to each of our service providers, and they basically have to compete with, with each other, and there's no, you know, there's no exclusivity from a geography point of view.
We may have, in some geographic regions, four or five different service providers. As a matter of fact, I was talking to one of our newer service providers and asked them, "You know, why did you move from Honeywell Resideo to Alarm.com?" He goes, "Well, your four other service providers were eating my lunch. So I had to, I had to, 'cause you have Alarm.com as a better solution, so I had no choice. Otherwise, I was going to continue to see degradation in my business." And so, you know, that's why, again, we're focused on providing the best solutions for the service providers.
Okay. A few more on my end, and if we have time, we can open back up at the end. Could you... We talked about the 18% margin profile. What's the typical conversion to free cash flow, and could you talk a bit about the section, your probably your favorite topic—the Section 174 Tax Act, and just how the impact that's having on you?
Yeah, Section 174 Tax. I love talking about tax, not. So, what was the first part of the question before the-
Just the free cash flow conversion.
Oh, so the free cash flow conversion. Yeah, I like talking about cash flow, too. So we are definitely cash flow positive. It's a very good cash flow generating business. If you think about from a cash flow conversion point of view, if you look at over the last couple of years, other than 2022, which was kind of unusual because of the supply chain and because of the, you know, the inventory we had to buy, typically, like last year, we generated about $140 million of EBITDA, and we had over $100 million of free cash flow. So it's about a 60%-65% conversion. Of course, tax is a big chunk 'cause we are profitable, which actually, if you think about it, for a SaaS software company, that's pretty unusual to be profitable.
The good news is we are profitable generating cash. The bad news is we have to pay tax. So there's a recent provision in the Internal Revenue Code called Section 174, which is penalizing companies like R&D who are investing in R&D, which is a surprising provision that actually came out of the Jobs Act back in 2017. It was effective in 2022. Effectively, what Section 174 does, it requires companies to take their domestic R&D from a tax point of view and amortize it over five years. International R&D, over 15 years. Now, most of our R&D is U.S.-based, so it's a five-year amortization. So what does that mean? From a tax point of view, it makes the company look a lot more profitable, and therefore, you pay more tax.
Now, there is an act in Congress that is pending that the Senate has to vote on to defer this, at least from a domestic R&D point of view. The Senate has not acted on it yet, and we're surprised they haven't. So, in April, in our Q2 of this year, we paid $43 million just for the R&D tax, which is crazy, right? That's related to the 2023 tax. Just like you have to pay your personal taxes by April 15th, companies have to pay their company tax by April 15th. So in April of this quarter, we paid $43 million just for that R&D tax, not accounting the other tax that we have to pay just for being profitable. So we're certainly hoping that the Senate does act on this.
For companies like in Silicon Valley that are startups, I don't know how they're doing it, where you have companies that are actually not profitable, not cash flow positive, but from a tax point of view, they look profitable 'cause most of their spending is R&D, and so they have to pay this tax. So it's a crazy penalty on companies that are innovating, and it just doesn't make sense, but anyway, we have to deal with it.
So we'll stick with the exciting topics. You have about $750 million of cash. You have $500 million 0% coupon convertible. Could you talk about your capital allocation priorities and how you're thinking about uses of cash, given your current profile?
Yeah. So I do believe in being net, having net cash. So, as you mentioned, we have about $250 million net cash. Now, of course, we pay $43 million, you know, for the tax we just talked about, so let's say $700 million of cash. So we have $200 million of net cash. We have a convertible that we that we did in January 2021, that's gonna mature in January 2026, a $500 million dollar convertible. I believe in, you know, making sure we have the cash on the balance sheet to cover that convertible. And so, you know, we have been buying back our stock in the past. We've, we've done some stock repurchases.
We have-- I think we bought it back about $85 million or so of our stock in the past. We still have about $70 million of authorized stock buyback. We've also done a number of acquisitions. Most of them have been smaller acquisitions, but over the last, I would say, seven years, we've probably, you know, acquired ten to 12 different companies. The largest one probably was Icontrol back in 2017, where we paid $140 million for that company. OpenEye, we acquired back in 2019. We paid about $65 million for that company, and that got us in the enterprise commercial segment. So we have been active in M&A. We're pretty selective, we're pretty cautious, but we do have an active team that's looking at various different M&A opportunities.
So, you know, having that net cash is very helpful.
I have one final question. We have time for one more for the audience—from the audience, if there is one. All right, I'll ask it then.
Yeah.
Just bigger picture, kind of what are the one to two things you're most excited about in the years ahead or that you think investors underappreciate about the business?
Yeah, it's a very good question. So a couple of things. One is, so when I started at the company seven years ago, we had about $260 million in revenue. This year, we're gonna report over $900 million in revenue. We guided to over $900 million in revenue. That's very good growth. We had $25 million in EBITDA. This year, we guided to $165 million in EBITDA. I don't think investors appreciate all the, all the effort and all the work that we've done to be able to generate that kind of growth, and I think when we look forward, I think there's tremendous opportunity for continued growth, continued innovation, continued opportunities in AI, in commercial, in video analytics. So I think the future is very bright.
Of course, you know, there's always gonna be competition, there's always gonna be bumps in the road. Nothing's ever a straight line, but I think we have a great opportunity ahead.
Great. We'll, we'll leave it there. Thank you, everyone.