Hey. Good morning, everyone, and welcome to day two of the Barclays TMT Conference. My name is Saket Kalia. I cover software here at Barclays. Very happy to have Steve Valenzuela, Chief Financial Officer of Alarm.com, with us here today. We've got about 25 minutes here together. Let's take maybe the first 15 or 20 minutes or so for some fireside chat with Steve, which I know is going to be fun. Then in the last five or 10 minutes or so, let's make this interactive. If anyone from the audience has got a question, just feel free to shoot me an email at saket.kalia@barclays.com. I'll be sure to weave your question in towards the end. With maybe that as a framework, Steve, thanks so much for being with us here today.
Thanks, Saket. Thanks for hosting this. You guys always run a great conference. I think this is almost our fourth year now, I believe. You've given us a full day of 101, so you keep us very busy.
I'm glad. You guys do that yourself with the metrics that you folks put up. Kudos, I reiterate, I'm glad to have you back at the conference. Steve, just for folks on the stream that are maybe new to the story, sorry, it's going to be a little bit of a high level question, but I think important to level set. Can you just sort of describe what interactive security means?
Sure.
What Alarm.com is providing and how you're monetizing it? Sorry, there's a lot there. Does that make sense, though?
No, absolutely. That makes sense. Before I forget, I should mention that there is a very thorough investor presentation at Alarm.com under Investors. If you click on the first few pages, there's a safe harbor, which I need to say that this presentation and our discussion and the 101s are all subject to the safe harbor. With that out of the way, yes, very happy to share with you what interactive security means, and Alarm.com really was the innovator here. The big differential here, and again, this applies for residential and commercial customers, is that with interactive security, it's a smart home system that you can actually interact with your security system and all of your smart devices outside of the home or even inside of the home with your smart device.
The difference being the legacy systems like Honeywell had prior to Alarm.com, you would come home, punch in your keypad, and there's still a lot of customers out there that have that. You punch in the keypad on the control panel to activate or deactivate the alarm. You couldn't interact with your alarm system outside the home. Interactive security really means being able to interact with your security system through your smart device, inside the home, outside the home. The key distinction here is you can use your iPhone, your iPad, your computer to interact with your security system. Now we have a lot more smart devices, including video and video analytics. That's really been a big game changer, and I'm sure we'll talk about that. That's probably a good, I think, maybe introduction or overview. Alarm.com really focuses on the software.
We provide a cloud-based software that we host for the dealers, and that's really our focus, is providing the best technology for our customers, the dealers, who then in turn market and sell and install and service to residential and commercial customers. Today, we have over 9,000 service providers. We call them service providers even though they're independent businesses and dealers. We really work closely with them, in terms of go -to -market, in terms of training, and then we have over 6.8 million end subscribers.
Got it. That's really helpful. I think it's kind of par for the course with every company that we've hosted here over the last couple of days, to ask about COVID. Maybe the question here for you, Steve, is, 2020 has obviously been a very unusual year. A lot of abrupt changes have happened in terms of buying habits and digital priorities. Can you just maybe give us a sense for how Alarm.com's business was impacted, either negatively or positively, even, perhaps, by these global lockdowns and work -from -home orders we all went through and are going through?
Yeah. No, that's definitely a timely question. In the March timeframe, when the pandemic really initially hit and all the shutdowns occurred, we had talked about on our Q1 earnings call that the activations were at about a 70% of pre-COVID levels overall. What we've seen since then is North American residential, a very good recovery. As a matter of fact, in Q2 and Q3, we saw a V-shaped recovery, and in Q3, you could even argue that our activations were actually higher than pre-COVID levels. However, commercial certainly has been impacted the most, as you would expect, with commercial businesses, both small business and regional businesses who we sell to, have been impacted because of the shutdowns. Even when restaurants and stores, coffee shops, and businesses were able to open at 25%, they weren't able necessarily to install security systems. Commercial's been impacted the most.
Commercial has seen a bit of a recovery in Q3 over Q2, and Q2 was a little bit better than Q1. We're probably running at about 70% of pre-COVID levels or so for commercial. International has also been impacted more than North American residential. Part of that is we have a number of new dealers who are ramping up and launching and replacing legacy systems that were delayed because of COVID, especially in Europe, where some of the countries were shut down, and there was more stringent shutdowns. Those new dealers will be rolling out the Alarm.com system to their existing subscribers, but it's just going to take a little bit longer. Overall, I think that we certainly would have preferred not to have COVID. Overall, I think we would be doing better without COVID.
Our results would be better, and we're looking forward to next year, 2021, when hopefully it's going to be safe to move around. I do think that a little bit more North American residential, I do give a lot of credit to our dealers, our service provider partners, who have figured out how to operate in this environment. A number of them got funds, PPP funds, and then they also used the equipment and protective equipment to be able to work in the homes and be able to make the customers comfortable that they were able to have technicians come in and check and make sure that the homeowner was not around. They've been doing a great job there. I think that's really helped North American residential.
I think another factor is that when we think of Alarm.com, our systems have mainly gone into homes and second homes. Not so much into apartment houses. The trend certainly we've seen this year, which is pretty clear, is that people have either added second homes in the suburbs, or they've moved to the suburbs, and that is a perfect target market for us and our dealers. We think we've benefited from that as well, and I think that's the trend that's going to continue. The great thing about the system, the Alarm.com system, is once you have it's very sticky.
You get all these benefits every single day, especially now that the system is not just an alarm system, but it's a smart system where you can remotely interact with the thermostat, you can see if your garage doors are closed, your video cameras, video analytics. There's a lot of value add there. We're really excited about how well we've done in North American residential and looking forward to hopefully recovering commercial and international next year.
Yeah, absolutely. That's actually a great segue into my next question here, Steve. Definitely want to be able to double-click on international and commercial, but I'd love to zoom in on U.S. residential first. Maybe the question is, can you just, broad brushes, of course, can you just talk about how big that market is and how much of that you think Alarm.com has captured so far?
Sure. Last time there was a market study done by Parks Associates, it's a couple of years, about three odd years old, so it is a little bit outdated. Parks Associates is a research firm that focuses on security and that market. What they identified was there's about 24 million homes in North America that have professionally monitored security systems out of about 140 million homes. Of those 24 million homes, only about eight million have interactive security, meaning that's our market. Again, about a year ago, we announced we had about 6.8 million subscribers, so we certainly have a large market share. The difference between that 24 million and eight million are the homes that have the legacy systems that are not interactive. They're landline- based, the keypad you punch in at home.
What we've been benefiting from is not just the overall growth of the market, but also the conversion, if you will, or upgrade of systems from the legacy systems to interactive systems that we invented, including the system as being cellular- based. It has a lot of capabilities and a lot of smart features versus the legacy systems. What's driving that is all these applications that we've come out with, including better video cameras, the smart thermostats. Video analytics has really been a game- changer. We came out with video analytics a couple of years ago based on an acquisition we did back in January 2017, where we acquired a company called ObjectVideo that was doing a lot of AI for the government.
They had about 17 employees, a lot of PhDs in video analytics, and we've added to that team quite a bit, and increased the amount of engineering focus there, a nd come out now with a system, a neural network system that can identify and distinguish between people, animals, and vehicles, and a lot of activity that's occurring. Both commercial and residential customers can use that for smart alerts. It's been really very helpful and very value- added.
Got it. Maybe building on that topic of video, Steve, one of the things that we've talked about in the few years that you've been coming to the conference is sort of the importance of video. The importance of video for dealers to generate higher ARPU from their customers as well as provide customers with richer security services. Maybe the follow-on question to that is: Where are we in video adoption here? Remind us, maybe broad brushes, of course, how accretive that could be to Alarm.com ARPU, if you will. Does that make sense?
Yes, it does. Definitely. It's a very good point. Yeah. Starting with where we are with video, a couple of data points there, and metrics. A little bit more than one year ago, we talked about, within a quarter, the attachment rate of video for new subscribers was around 25%-30%. This last quarter in Q3, the attachment rate, meaning of the new subscribers, what percent included video, was around 40%, and about half of those had video analytics. That's important because if we have a subscriber that has video, we're charging the dealer a little bit more. If you think about the average ARPU, we charge the dealer for residential would be in the mid $5 range. If the end subscriber has video, then it's probably going to be closer to $6. Again, it depends upon the dealer, but just giving you some averages.
$6 per month, we charge the dealer. For video analytics, we charge an additional $0.80 - $1 to that dealer. The dealer, in turn, charges to the end subscriber for residential, on average, $45-$55. If the system includes video analytics, they're probably on the high end of that and maybe even a little bit more. The model that we've deployed is one where we don't really raise prices to dealers or haven't in the past. What we do we provide new features, new services, if you will, solutions that the dealers can then also pass on higher value, add to the end subscriber and then also charge a little bit more. A good recent example is Flex IO that we just introduced in Q3 that we're really excited about.
This is a sensor that can now be used for sheds, for gates where you don't have electricity and you don't have Wi-Fi. It's cellular-based and battery-operated. We've gotten very good feedback from dealers on that, and it's new, so we'll see the ramp, but we would expect that should do really well. That's another example of where we will be able to monetize that by charging the dealers $1 or $2 more per month per sensor, and then the dealers can charge a little bit more to the customer. These numbers are all residential. For commercial, the ARPU is closer to an average of $10 per month that we charge the dealer, and then the dealer charges the end customer, the commercial business, on average around $100 per month. That's for Alarm.com for business.
On top of that, we have access control for business, where if a commercial customer has access control, we charge that dealer $3 per door per month, which can add up pretty quickly. If the commercial customer doesn't have Alarm.com, they can still have access control, and we charge the dealer $4 per month per door. That's a new offering that we came out with a couple of years ago. It's new, so it's been relatively slow in terms of the ramp on that one, because there is some training involved, and there is some hardware that has to be installed on the doors. Now we probably have over 1,000 dealers that have been trained and installing access control. Whereas for commercial, over 50% of our commercial service providers/dealers have installed the commercial offering in the last year.
Got it. That's a great segue into the topic of commercial here, Steve. I'm not sure if it's been quite a year yet, but Alarm.com acquired a company called OpenEye that really gives you more enterprise exposure, with a SaaS solution, if I'm not mistaken. Can you just give us some thoughts on how the integration of OpenEye has gone and what benefits they bring to the table, if you will?
Yes. We actually acquired a little bit more than a year ago, in October of 2019. OpenEye was not looking to be acquired. They were actually raising their first round. They had been self-funded. We came across them and realized that this is a company that had the same culture of Alarm.com, a focus on technology, very good customer satisfaction, very much focused on customer service. They had about 420 service providers, dealers, only about 15% overlap with Alarm.com. We saw a good opportunity here to take our commercial offering, which is really targeted for small business, and expanding that into the enterprise. What OpenEye provides is a cloud-based enterprise solution for businesses like Olive Garden, Gonzaga University. There's other large customers we can't talk about with the national franchisors. They sell through these integrators and also through universities and schools.
It's a great complement and a great expansion of the Alarm.com offering, and expands us into a $4 billion TAM market for the enterprise segment of commercial. Prior to the acquisition, OpenEye was really providing, again, a cloud-based solution, but they were pricing it as a term license to get the payments upfront. We've come out now with a SaaS offering to increase the SaaS revenue from OpenEye. Whereas prior to the acquisition, their SaaS revenue was fairly small. For 2020, the SaaS contribution from OpenEye will be about $1 million, but we expect in the future years, that to go up quite a bit now that we've come up with a SaaS offering for OpenEye, and in fact, for the Alarm.com dealers, they can only sell a SaaS offering. We think it's a great offering. The integration's done really well.
Matter of fact, we've actually been investing in engineering. We've added more sales reps, because OpenEye sales is more of an enterprise sale because the team at OpenEye is working with large integrators who are selling into large franchisors, university systems. That does require a consultative sale, enterprise sale. We've invested, added a few more sales reps. We probably would have added more had it not been for COVID. We'll probably add more next year, and we're expanding their facilities. What's nice about OpenEye as well, we've retained all of the management team, and I think that's part of the philosophy that Steve Trundle brought over from MicroStrategy, because remember, Steve Trundle incubated Alarm.com in MicroStrategy for eight years when he was CPO there.
When we acquire these companies, we retain the management team, and that's very important to us, and we really scrutinize and look at part of our diligence, the management team, to make sure that they have the same motivations we do. The good news with OpenEye is all the management team has been retained. They still have their identity. They get the benefit, of course, of our overall G&A and our ability to fund operations and help them grow. I think what the OpenEye team saw here is a company where they weren't selling out, they were joining up. That's the kind of companies that we like to acquire, where they still have an identity, very much like Steve was incubating Alarm.com and MicroStrategy. OpenEye still has its identity, but they get the benefit of overall G&A and overall marketing.
They have, of course, their own marketing. We actually are expanding their operations in Spokane, Washington, which is a new regional area for us, so we can tap into some of the engineering talent in the Washington, Seattle area, which Spokane is a few-hour drive from Seattle. We're very excited about OpenEye.
Yeah, absolutely. Definitely a thoughtful M&A strategy by Steve Trundle and the team.
Yeah.
I want to, in the time that we've got left here, Steve, I want to maybe shift and talk a little bit about ADT. Because you spent a little bit of time on this on your last call. I believe Alarm.com's agreement with them was due to expire in mid-2021. Steve Trundle, I think, talked about the renewal and extension here. I'll open-ended the question to the extent you can, anything you can share on how that contract is changing, and perhaps how other parts of the business could be important as that contract changes, I think in 2023. There's a lot there. Does that make sense?
Yes. We talked about on the call that we extended our agreement with ADT, which was set to expire in August of 2021. We extended that to the beginning of 2023. We're excited to do that. We have a great relationship with ADT. The way the agreement is that Alarm.com will continue to operate the end customers of ADT, both those ones that Command and Control and on Connect, their Pulse application that we licensed to them through their natural life, even after the contract expires, and then subject to the churn rate. For customers that ADT adds onto a system that they're hoping to come out with, they would pay us a license fee in recognition of all the patents we have. The good news is here is both ADT and Alarm.com came together.
We have a great relationship with them, and we're continuing to support them. In 2023, if they need more time, we'll be there. Throughout this whole process, it's been very good. ADT's been very clear to let us know that it's really more of their goal of having their own system, nothing that Alarm.com did or didn't do. We've been a great partner to them. It's more of an initiative they have internally. We're happy to have renewed the agreement with ADT and extended to 2023. In the meantime, we're continuing to invest in our growth areas. We talked about, and to answer your second part of your question, the growth areas that we've been really investing in, the large ones are international, commercial, video, and video analytics, and energy. EnergyHub, which is doing really well.
That overall group represents about 22.5% of our revenue and grew over 40% year-over-year, even in a situation with COVID. That does not include ADT. We think that we will see continued good growth there, especially after COVID. We're excited about the opportunities there, and we're obviously investing in other areas as well. Just like we came out with Flex IO, we came out with a Smart Water Valve+Meter. Alarm.com is very much a focus on a SaaS engineering development effort, where we continually come out with new innovations, new products, new technologies to make sure our service providers have the latest and greatest technology. Because they're all competing against each other. All the service providers of Alarm.com benefit from our overall R&D effort.
Also, of course, we're hosting all this data for them in our cloud. They get a lot of economies of scale, and they get the best technology. We're continuing to invest in our AI neural network, we have the best AI system out there. The Alarm.com dealers will continue to benefit from that level of investment, and it'll be hard for others, I think, to keep up, quite honestly.
Yeah, sure. No, definitely a lot of seeds planted here over the years. We've definitely seen that. Steve, maybe in the few minutes that we've got left, I've got so many more questions, but unfortunately limited time. One of the things that's always helpful that Alarm.com does, particularly in their Q3s, maybe give some broad brushes on what the out- year guide could look like.
Yes.
I think one point that's worth calling out here is the profitability in the business, even with a hardware business as part of this. I guess the question is, can you just remind us what you said about EBITDA profitability for next year? Maybe what are some of the moving parts to consider in that, high level, of course?
Yeah. We started this a couple of years ago, providing an initial look for the next year. For like you said, in a future earnings call, we gave an initial look. It's not really our guidance, it's more, "Hey, we're in the planning process. Here's where we are seeing 2021 at this point in Q3." Part of that reason is because the time between the Q3 earnings release, beginning of November, to when we issue our financial results in February, going through an audit, is a fairly long period of time. We respect analysts like yourself that need some guidance, and we also don't want you to get too carried away with the...
Absolutely
results we have. We like to put out some initial feelers out, initial numbers out there. We talked about on the Q3 call, the EBITDA for 2021 would be around $120 million, which is just a little bit shy of a 20% of revenue. That's kind of been our target, 20%-25% EBITDA. That's in a situation where we still, in those initial numbers, still have to factor in that we still have COVID. We're not planning in those numbers that there's a full recovery. We still anticipate or plan for some headwinds in commercial, some headwinds in international. If we're surprised and pleasantly surprised, then we'll have some good upside. That's kind of how we look at it and the numbers we came out with. With that $120 million, we generate a very good amount of cash flow.
Typically, around 60%- 65% of EBITDA flows to cash flow. This year, we'll do over $65 million of cash flow. We generate a very good amount of cash flow. At the same time, we're still investing very good rate, 25% of our revenue goes into R&D. We're continuing to make the innovations and investments while generating a good amount of cash and EBITDA for our shareholders and providing a good return. We think that's the right model.
Got it. Well, again, Steve, as I said, a lot more to dig in here, but unfortunately limited time. Thanks a ton for being with us here today. Look forward to being able to do this in person again in San Francisco, like we have the last few years.
Saket, I definitely look forward to doing this in person next year. Absolutely. Thanks so much.
Same here.
Take care.
Same here. Absolutely. You too. Bye now, Steve.
Thank you. Bye-bye.