Hey everybody, this is Nikolay Beliov, Software Analyst at Bank of America. We're happy to have today with us, Steve Valenzuela, the Chief Financial Officer of Alarm.com. Thank you, Steve, for joining our conference.
Thanks, Nikolay. Great to be on, and as we were talking, hopefully next year we can do this safely in person in sunny San Francisco.
That would be fantastic. Let's just jump right in. To start off the conversation, how has COVID impacted your business? What are you seeing as durable trends coming out of COVID? What is your best assessment of how that might impact your business and business model in the long term?
Nikolay, that's certainly the question of the hour and the month, certainly the focus. Before I begin, I did want to mention that investors can go to the investor section of our website. We actually have a very detailed investor deck there that provides a lot of information we can't cover in the next 30 minutes.
It also includes our safe harbor statement on page two, which I will have to say that this discussion is subject to the safe harbor. Going back to your question on COVID, certainly that is a key point of discussion. We talked about on our Q1 earnings call on May 7th, that at the low point in March, gross adds were running at about 70% of pre-COVID. Prior to that, in January, February, and last year, we were seeing a good amount of gross subscriber adds.
The good news is, as we said on the call, is we've seen a recovery from that, from the 70% of gross adds, pretty much tied to the opening of the states and the geographies, the relaxing of the shelter in place. For the year, is that we've guided, factored in basically that we expect to be at about 95% of pre-COVID gross adds by the fourth quarter.
Now, I have to caution that assumes that there's not a second wave and another second wave of shutdown, which we can't predict or plan for that. I would say the good news is that our retention has been rock solid. No difference between post-COVID to pre-COVID. That kind of makes sense because in a time of uncertainty, people need more security. They need to be assured.
The need is even greater, I would say. I think we're very encouraged. We go to market through over 9,000 dealers who we call service providers. These are independent businesses, ADT being the largest. They've really done a great job of adapting to this situation and making sure they provide their employees the proper protection, making sure they take precautions going into homes and businesses.
While obviously this is a very serious situation with COVID, first and foremost, we want our service providers and their technicians to be safe. They've really done a great job of working around the situation. Some dealers were shut down for a period of time. Other dealers really continued to operate pretty much at 100%. It really depended upon the location.
I would say one thing that I think is probably helpful is that, when you think about Alarm.com, it's really geared, at least the residential business, really geared for homeowners. In some of the larger cities where you have a lot of concentration of people like New York City, for example, we actually haven't had a lot of business there because that's mostly apartments. I think, given the way that the dealers have responded, I think our business has been very resilient compared to a number of other businesses.
As I mentioned, we've continued to see a good recovery from that low point of 70% of gross installs. I think Europe was actually a little bit worse than that in terms of the shutdown was more severe for a number of months, they've come back as well.
I think all in all, we're quite encouraged with the resiliency of our service providers and of our business model.
Steve, can you please comment on the long-term impacts of COVID on your business? For example, if you can touch on, would you envision the industry would steer towards more remote installation, et cetera? What do you see as the durable impacts coming out of COVID on your business and the business model for your service providers?
Yeah, we haven't really seen much of that. There has certainly been some dealers who have taken this time to provide upgraded cameras to subscribers and mail them out and talk them through actually installing those. I think the dealers, again, have been able to make sure that they take precautions going into homes or businesses, make sure that the homeowner or the business person is not leering around the technician, and then providing the protection equipment to the technician.
I do think that if anything, in a time typically of uncertainty, security is more important. Typically what we've seen in past, let's say recessions, my understanding is security has done quite well. I do think that there is a lot of resiliency in this model. People need security. People need the capabilities that you have with a smart property.
One thing that's interesting too is for businesses, we've actually seen some dealers actually have seen a uptick in business from small businesses. As you can imagine, some of them have security, but they don't have the interactive security cameras as much that they can use outside of the business. Where the business is sometimes shut down.
They've actually seen an uptick in some areas. Anecdotal information indicates that businesses are taking this time to upgrade their security system so they can monitor what's happening in their business when they're not at the establishment. So, we think that's been part of the helpful part of the business model that's complemented the gross add, subscriber add coming back up from that low level we talked about.
On that note, let's talk about the commercial offering. Could this be a potential significant business driver for the business? As businesses reevaluate their real estate strategies with COVID and post-COVID, what are the threats and opportunities in your mind here?
Yeah. Our commercial offering is not really geared toward commercial properties in terms of office buildings. It's really geared toward commercial businesses. We started Alarm.com for Business in about April of 2018, and really geared towards small businesses, coffee shops, restaurants, insurance agencies. Small businesses.
You might have a business owner or it might be a Wendy's franchisee who might have five different locations or eight different locations. We think the need for the interactive solution is even more important today b ecause if you think about a business owner, they've got to manage what's happening at their establishments in multiple, different locations.
Being able to see on the cameras, what businesses are having a longer wait time, to be able to use our video analytics capability to see what's happening around their property and make sure nobody's leering in the back of their establishment, from a security point of view.
There's a lot of features that come with Alarm.com for Business that's different than the residential. For example, auto alarming. A lot of employees sometimes forget to alarm at nighttime when they close the store, and the commercial business auto alarms if the employee has not turned on the alarm system. We're using our AI capability to provide more and more capabilities for the business owners. We think that there is a lot of opportunity.
When you think about commercial, it's probably less than 8% of our SaaS revenue today. There's quite a bit of opportunity. When you think about OpenEye, for example, that we acquired in October last year, that expands our solution from small business into the enterprise.
What OpenEye does is provides a commercial, cloud-based security system with recorders and typically many more cameras than the small business offering we have to large integrators who put those into large establishments and nationwide franchisors. Some customers we can talk about are Olive Garden, Bed Bath & Beyond, and a number of other theme parks, which we can't name, nationwide restaurants, franchisors. It's geared toward larger installations, also including universities are also customers, and high schools or such.
I think that, obviously the world is not getting any safer, I think OpenEye solution is even more relevant today than it's been in the past couple of years, given the need for security to monitoring what's happening around the multiple different locations. We're excited about the opportunity with OpenEye.
Steve, you mentioned you work with 9,000 service providers. How many of those also do commercial, and where are you in terms of channel adoption, service provider adoption of the commercial offering today?
Yeah, that's a good point. One way to look at this is to distinguish two. With OpenEye, which we acquired right recently in October, they had a little over 400, what we call service providers. A little bit different than the Alarm.com 9,000 service providers. The 400+ , there was only about a 15% overlap with Alarm.com dealers. Most of the OpenEye dealers are large integrators that sell into commercial businesses.
They might be selling commercial refrigeration systems, other kind of equipment, and they'll bring in OpenEye for the security system. For the Alarm.com 9,000 dealers, all of them really can do commercial. It's not that big of a difference, really, in terms of the implementation. What we've seen in the past 90 days or so, about 25%-30% of the 9,000 service providers have implemented a commercial solution.
One distinguishing factor is access control, which is a complementary solution to our Alarm.com for Business, which is really new. That's the area where we need to train the dealers on how to implement access control, because you have to put in effectively some hardware on the doors of the establishment, and we actually use it in our headquarters here in Virginia.
That's an area where we've been training the dealers over the last couple of years of how to implement that, how to be able to use it. The idea with access control is that it complements the Alarm.com for Business because the business owner can provide electronic access to their employees and quickly target, if you will, certain access times for various employees just using a computer screen. The employee can use their smartphone to unlock a door.
It's quite a big capability. It is a new offering, relatively speaking, so that's an area where we've had to train the dealers. That's kind of distinguishing between commercial and access control. There's been some confusion in the past about kind of combining those two, and in fact, it's separate.
Commercial Alarm.com for Business is very well addressed by a lot of Alarm.com for dealers. It's just the access control is the new offering that takes some training and learning how to set those up, how to implement those, how to set up the dashboards for the businesses to be able to provide access to their employees.
Got it. The acquisition of OpenEye increased the hardware contribution of the revenue mix by 10%. What's your view, as a CFO, where the software versus hardware mix goes over time and in the long term?
Yeah. Given that we really focus on the recurring SaaS revenue, the software, because the gross margins there are around 86%+ , then the hardware gross margins are in the low 20% range. We have, over the last couple of years, added a number of capabilities with our video and video analytics that really has driven a big increase in hardware.
If you look at, for example, in Q1, hardware revenue was up, I think, over 80% year-over-year, and a lot of that was driven by video. Video is something where we really believe that we have to provide, at least today, the video cameras based upon the capabilities that you need the right kind of chip built into the camera to be able to take advantage of our video analytics system.
Ideally, over time, we'd like to see hardware ideally less than 30%, but at the same time, video is complementing the adoption of the security system and the smart property. It is kind of a good news situation where more video ultimately leads to more SaaS and a higher, we think, lifetime value b ecause as subscribers can take advantage of the video analytics capability, they're using the system every day.
They're seeing what's happening around their property every single day, so they get a lot of value add. We're hopeful over the next few years, that that will actually translate even to a higher subscriber retention rate.
Got it. You mentioned that commercial is less than 8% of the business. Are you talking about commercial?
8% of SaaS, sorry. 8% of SaaS.
What was that number a year back?
That's a good question. I don't have that right off the bat. I would just say generally, commercial hardware and software has been running at a higher growth rate than residential. Let's say, on average, it's been growing at about 40%+ per year. It'll give you some idea.
Okay. Got it. Where do you think the 8% goes over time?
Well, one of the things we're excited about with OpenEye as well is our video analytics engineers are working with the OpenEye engineers to adopt those capabilities in the solution for OpenEye. You can imagine if you have, let's say you have a franchisor or a university with 100 or 500 cameras.
If you have the video analytics capability of monitoring those locations and having smart alerts, we think that'll provide a lot of value add. We think there's a lot of capability there for the capabilities for commercial. We haven't really set necessarily a target. I think given the growth and given the opportunity and given the TAM, because you think about in North America alone, there's 4 million properties that we think would qualify for our small business Alarm.com for Business.
With OpenEye's cloud-based solution, the TAM that I've seen there is multiple billions. I think it's $4 billion TAM or something like that is the opportunity. Hopefully over time, we think commercial can continue to increase as a percent of revenue and percent of SaaS.
Got it. Switching gears to the international opportunity, if you can give us an update there.
International, we've been seeing good growth there as we've added a number of new subscribers internationally, through a number of dealers, and we've expanded the economies that we've been able to enter into. Now we have, I think, over 40 countries that we're in internationally.
The way we've been doing that is very much similar to how we've addressed the North American market, is by signing up key dealers in various markets to be able to train them and then have them come up to speed on the Alarm.com solution. It's a little bit more time-consuming internationally. You've got different standards you've got to meet, and then you've got different cellular partners you have to work with, because our system, of course, is cellular based but International last year was about 3% of our revenue.
We signed up a number of new dealers who are converting some legacy systems to the interactive system. Now, I will say that COVID certainly has slowed that down a bit, and so we have some delays with those new dealers actually rolling out because of the shelter in place. It's just a matter of a delay. It's ultimately going to be implemented. Probably will be delayed till later next year, or maybe later this year, I should say, or early next year. International has been growing at a good clip. Again, it's only 3% of revenue.
Given the TAM, we think that the opportunity internationally is as large as North America. What we would hope is over a number of years, and we obviously haven't indicated how many, we don't really know for sure, but hopefully over some period, international could represent 25%-30% of our revenue.
Got it. Switching gears to service providers, which as a B2B business model, they're customers at the end of the day. How would you evaluate and how do you monitor the health of the service providers?
We have a range of service providers, all the way from the largest, of course, being ADT and then some smaller service providers. All of them are independent businesses. I would say that they've been, again, very resilient.
Some of the smaller ones have been able to get the funding through the government, the PPP funding, which was good, and in fact, we connect and we have discussions with the service providers on a number of occasions and have close relationships with them to see how they're doing.
We look at our receivables from the service providers on a regular basis. If you look at our DSOs, for example, at the end of March for Q1, DSOs were 49 days, which reflect to DSOs as of December, 49 days.
Now Q2 will probably be a little bit higher because one thing we have done is we have informally given a little bit more grace period to our service providers to give them a little bit extra time to pay, maybe 15 days or so, just informally and not really press them.
I think that's been helpful. I would say that generally, the service providers are quite resilient because one thing to think about is that some of the service providers, if they need to raise cash, they can actually sell accounts because the accounts are considered annuities and there's a financial market for those accounts. There are some dealers that actually buy accounts from other dealers. It builds a lot of resiliency into the business model.
If a service provider does need to raise cash, they can sell the accounts at a multiple of RMR. They don't like to do that because they want to keep, obviously, that recurring revenue. It helps to backstop the service providers. To date, we certainly have not lost a service provider. We've seen them, some do better than others, of course. Overall, I would say that there's not been a major change with COVID compared to pre-COVID in terms of the service providers.
Just a reminder to the audience, you can ask a question anonymously in the chat box. Feel free. Steve, switching gears to some of the numbers here. You mentioned in the beginning of the conversation some of the assumptions underlying the 2020 revenue guide.
Yes.
Can you help us with some of the math here? If new business is down 30% in the near term, how can you mathematically grow subscription revenues in the 12% revenue guide range for 2020 that you gave?
By the way, Nikolay, that's my favorite question.
Okay, great.
The reason is because the beautiful thing about the recurring nature of the SaaS business is that a lot of our revenue this year is in SaaS. It's based upon the subscribers we added last year because if you think about the stairstep of the SaaS business grows on top of it.
For example, the SaaS subscribers we added in Q4 of last year only contributed, let's say, a few months of 2019, but they contribute all of 2012. You can't just say, well, if your business is down 30% gross adds, that means your SaaS is going to go down for a couple of reasons. One, because of the way the stairstep of the SaaS reoccurs, and you get the full benefit this year of the subscribers you added partially last year.
Second of all, we said that the business was down 30% at the low point. That's a short period of time, and we've said we've guided based upon the recovery to the point where by Q4, we would be at 95% of gross adds compared to pre-COVID but again b ecause of the nature of the SaaS business, it's highly predictable.
Obviously, the growth we've guided to is a little bit less than the guide pre-COVID, and it's actually 99% for SaaS of the pre-COVID guide. That's because of the SaaS model, because of the recurring predictability of the model. That said, clearly next year's SaaS will be slower growth than we would have otherwise had it not been to do the slowdown of COVID just because of the way the SaaS grows.
I think, given the guidance we provided this year of low teens, I still feel comfortable with the low teens SaaS growth going forward even with the COVID slowdown. That's the reason why it's the way the business model, way the SaaS revenue stairsteps on top of the previous subscribers added.
Okay. Another interesting trend in the numbers we noticed this quarter in Q1 relates to the other segment, which is your energy business, your rental business, vacation rental business. In Q1, that business, other SaaS business, was down 2% year-over-year on what looks like tough comps.
Yes.
Which means that the core SaaS business actually accelerated in Q1 to 15.9% versus 14.6% in Q4 after it bottomed out in 12.6% in Q3. What is driving this reacceleration in the core SaaS business when you look at the other segment? If you can just also talk about the seasonality of the other segment, which was a headwind in Q1?
Yes
should we expect to become a tailwind for the business for the remainder of the year?
Yeah. There was one thing that occurred in the other segment, in Q1. In Q1 of 2019, there was a new program that was signed up by EnergyHub for gas in California, which was a new innovative program. All of EnergyHub's has previous always been electrical. I think what happened is that program did not get renewed by the regulators.
The utility wanted to continue with that program, but they had to get approval by the regulators. I think given what's happened in California with everything else, and as you can imagine with PG&E and everything, I think their focus is on other areas. That program, which was a seven-figure program a year ago, did not reoccur in Q1, and likely won't reoccur. That was a headwind, if you will, in Q1, but at this point, we don't see any other headwinds.
In fact, we think based upon the utilities that EnergyHub have signed up, we think it'll be a tailwind going forward. There is some seasonality that occurs. With EnergyHub in Q4, typically, we get the benefit of the energy savings in the summer months that contribute to the Q4 number. That's really the only seasonality for the other segment business from that perspective. I think that answers. Was there another part of your question?
Yeah, the other part was when you adjust for that, the core SaaS business excluding-
Yes. Oh, yeah. Yes, of course.
other SaaS, has been reaccelerating after bottoming in Q3 last year.
Yeah, and I think-
What's going under the covers here?
A combination of things. Again, it's the subscribers that we added last year that we got the full benefit of this year. Last year, we did have some hiccups, if you will. From time to time on the SaaS revenue, we weren't able to recognize all the SaaS revenue in Q1, and we've kind of worked through that so t he main thing was that we've been expanding commercial and international, and we're starting to get the contribution of those subscribers into our SaaS revenue.
That's really the main reason. With the investments we've been making in commercial, international, and then also video analytics, because as you know, video analytics increases the ARPU that we're able to charge the dealer, and the dealer is able to charge the subscriber.
It's really mainly the addition of new subscribers across the company, both in commercial and in residential, international, that's really contributed to that. Again, it's the way that stairstep works with SaaS. You don't get the full benefit right away, right? The subscribers you add in a quarter, you only have maybe a month and a half for the full effect of that. The following year, you get the full effect. That's the way the model works.
Got it. We touched on a few of the growth drivers of the business. To maybe help us put it all together, Steve, can you stack rank them going forward in terms of impact to the numbers? International, commercial, other SaaS, et cetera. You mentioned the 40% growth in commercial. Just maybe help us stack rank them and put all these growth levers in context, in relation to each other.
Yeah. I like this question, too, because it's kind of like, which child do you like the best? I love all my children. No, it's a great question because there are a number of good growth drivers here, and it's hard to say which one is stack ranked over the other because of the investments we've made in international, commercial. Both are growing at good clips.
Video analytics, I would say is also a very good growth driver because of the capability it provides in terms of the end subscriber being able to get value-added information every day and value-added alerts every day on what's happening with their system. I would say all of those are really good growth drivers, and just generally, the way the company is focused on providing technology to expand the use of the smart system.
With security being the hub of the smart property, we really think over the next 10 years that every property should be and could be a smart property, either commercial or residential. We think that we have the opportunity, given our technology with our dealer base, to be able to be the leader in that area.
We think security is a great platform to build off the smart property. We're continuing to invest in new technologies. In fact, even during this period of COVID time, we've been quite successful in hiring a number of key engineers, and we continue to hire engineers. I would say we're not at the level we planned for the year given the limitations of hiring, but we've continued with our intern program. We have all of our interns starting. Actually, just started.
We have a number of key engineers we've hired, and so we're continuing to invest. There's a lot of interesting technologies that we're continuing to work on that we think will make the system even much easier for the end subscriber to use, better technology for the dealer b ecause again, the dealers use our technology in much of their back end to be able to manage their business in terms of what's happening with the installations, being able to easily do remote diagnostics. There's a lot of tools we provide the dealers as well. It's really the focus on technology innovations to make the system much more capable.
We have time for one more question. I would like you to talk about your view on the competitive landscape. What are you seeing out of the cable providers? What are you seeing out of DIY? Seems like the DIY wave has quieted down a little bit. I just wanted to get your perspective on different aspects of the competitive landscape.
Yeah. We definitely have a number of competitors, and internationally it's different than it is in North America. I would say the historical competitor has been Honeywell. They're really the legacy provider, mainly of the hardware and of the legacy landline security systems. Honeywell spun out Resideo, that's, I would say, really our key competitor now. There are some smaller competitors that have just maybe 100,000 or so subscribers or less.
Those are private companies that I'm not going to name. You could say there are indirect competitors for our dealers, although these tend to be more point solutions, what you call for DIY, where somebody might want to put in a thermostat, they might want to put in a camera. Obviously, there are some DIY providers out there have been advertising like crazy.
I think what we've seen is it's a different consumer, different use case. If you have an apartment, if you're not that worried about security, you might want to put in a DIY system. If you have a vacation property, you have your home, you want to be able to use your system, you want to make sure it's going to work every time.
We really go to market first and foremost focused on safety and security, we add on top of that all these smart home features. Our go to market is very much different than the DIY, which is more about simplicity and point solutions, I would say. For some apartment owners and stuff, it's a fine solution.
Got it. Steve, any closing remarks on your end before we wrap it up?
No, I would just say really appreciate the time, and thanks to everybody on the call for taking time today and your interest in Alarm.com. Nikolay, as we talked about at the beginning, I really hope next year we can do this safely in person in San Francisco.
Yeah, look forward to that, Steve. Everybody please stay safe and healthy. Thank you, everybody.
Thank you.
This concludes our presentation with Alarm.com. Thank you.