Bank of America Merrill Lynch 2020 Global Technology Conference

Jun 2, 2020

Hi, 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, Nikolai. Great to be on. And as we were talking, hopefully, next year, we can do this safely in person in San Francisco, sunny San Francisco. That would be fantastic. 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? And 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 Investors section of our website. We actually have a very detailed investor deck there, that provides a lot of information we can cover in the next thirty minutes. It also includes our safe harbor statement on page two, which I will have to say that this, this discussion is subject to the safe harbor. So going back to your question on COVID, certainly, is a key point of discussion. We talked about on our q one earnings call on May 7 that at the low point in March, gross ads were running at about 70% of pre COVID. And prior to that, in January, February, and last year, we were seeing a good amount of gross subscriber ads. The good news is, and as we said on the call, is we've seen a recovery from that, from the 70% of gross ads, pretty much tied to the opening of, you know, the states and the geographies, the relaxing of the shelter in place. And what we've for the year is that we've we've guided, factored in basically that we expect to be at about ninety five percent of pre COVID gross adds by the fourth quarter. Now I have to caution that that assumes that there's not a wave and another wave of shutdown, which we can't predict or plan for that. But I would say the good news is that our, retention has been rock solid. No difference between, you know, post COVID to pre COVID. So, and that kinda makes sense because, you know, in a time of uncertainty, people need more security. They need to be assured, and, so the need is even greater, I would say. But we're I think we're very encouraged. You know, we we go to market through over 9,000 dealers who we call service providers. These are independent businesses, ADT being the largest. And they've really done a great job of adapting to this situation and, you know, making sure they provide their employees proper protection, making sure they take precautions going into homes and businesses. And so, while, obviously, this is a, you know, very serious situation with COVID, and foremost, we want our our service providers and their their technicians to be safe. And, but they've really done a great job of of of working, know, around the situation. Some dealers were shut down for a period of time. Other dealers really continue to operate pretty much at a 100%, and so 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, you know, at least the residential business, really geared for, homeowners. And so 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. And so I think, you know, given the the way that the dealers have responded, I think the, our business had been very resilient compared to, a number of other businesses. And as I mentioned, we've continued to see a good recovery from that low point of 70% of gross installs. You know, I think Europe was was actually a little bit worse than that in terms of the the shutdown was more severe for a number of months, but they've come back as well. So I think all in all, we're quite encouraged with the resiliency of our service providers and of our business model. And, Steve, can you please comment on the long term impact of COVID on your business? For example, if you can touch on, would you envision the industry would steer towards more, remote installation, etcetera, etcetera. 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, you know, provide upgraded cameras to subscribers and and mail them out and then talk them through, actually installing those. But I think, the dealers, have been able to make sure that they're take precautions going into homes or businesses, make sure that the the the homeowner or the business person is not, you know, leering around the technician, and then providing the protection equipment to the technician. I do think that if anything, you know, in in a time typically of a of of uncertainty, security is is more important. And, typically, what we've seen in past, you know, let's say recessions, my understanding is security has done, you know, quite well. I do think that, you know, I do think that, there is a lot of resiliency in this model. People need security. People need the, the capabilities that you have with a smart smart property. One thing that's interesting too is for businesses, we've actually seen some dealers have seen an uptick in business, from, small businesses. As you can imagine, you know, some of them have security, but they don't have the interactive security cameras as much that they can use outside of the business. And with the businesses sometimes shut down, they've actually seen an uptick in some 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. And so, we think that's been part of the, you know, helpful, part of the business model that's complemented, you know, the gross ad, subscriber ad coming back up from that low level we talked about. On on that note, let let's talk about, the commercial offering. Could this be a a potential, significant business driver for the business? And as businesses reevaluate their real estate strategies with COVID and post COVID, what are the threats and opportunities in your mind here? Yeah. So our commercial offering is not really geared toward, like, commercial properties in terms of the, you know, like, like, office buildings. It's really geared toward commercial businesses. And so we started the Lundbeck office business in about February and really geared towards small businesses, coffee shops, restaurants, insurance agencies, you know, small businesses. You might have, you know, a business owner or it might be a Wendy's franchise franchisee who might have five different locations or eight different locations. And so we think the, you know, the need for the interactive solution is is even more important today because if you think about a business owner, they've gotta manage what's happening at their establishments in multi built different locations and being able to see on the cameras, what businesses are, you know, having a longer wait time to be able to use our video analytics capability to see what's happening around their property, make sure nobody's leering in the back of their establishment, you know, from a security point of view. And there's a lot of features that come with a longer for Business that's different than the residential. For example, auto alarming. A lot of, you know, employees sometimes forget to alarm at nighttime when they close the store. And the, the the commercial business auto alarms if that's if if, you know, if the if employee is not turning on the alarm system. And then we're using our AI capability to provide more and more capabilities for the business owners. So we think that there is a lot of opportunity. And when you think about commercial, you know, it's probably less than 8% of our SaaS revenue today, so there's quite a bit of opportunity. And, when you think about OpenEye, for example, that we acquired in October, that expands our solution from small business into the enterprise. And what OpenEye does is provides a commercial, cloud based security system with recorders and and typically many more cameras than the than the small business offering. We have two large integrators who who put those into large establishments and nationwide franchisors. Some customers we can talk about are like Olive Garden, Bed Bath and Beyond, and a number of other, you know, like like theme parks, which we can't name nationwide restaurants, franchisors. And so this geared toward, larger install installations and also, including universities are also customers and high schools are such such. So I think that, you know, obviously, the world is not getting any safer. So I think OpenEye solution is is is even more, relevant today than, you know, it's been in the past couple years given the need for security to monitoring what's happening around, you know, around the multiple different locations. So we're we're excited about the opportunity with OpenEye. And, 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 of the commercial offering today? Yeah. That's a good point. One way to look at this is to distinguish too. So 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 plus, there was only about a 15% overlap with alarm.com dealers. So most of the OpenEye dealers are large integrators that sell into commercial businesses. They might be selling commercial, you know, refrigeration systems, other kind of equipment, and they'll bring an open eye for the security system. For the lawn.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, ninety days or so, about 25 to 30% of the 9,000 service providers have implemented a commercial solution. One distinguishing factor is access control, which is a complimentary solution to our alarm.com for Business, which is really new. And that's the area where we need to train the dealers on how to implement access control because you have to put in, you know, effectively some hardware on the doors of the establishment, and we actually use it in our headquarters here in Virginia. So that's an area where we've been training the dealers over the last couple years of how to implement that, you know, how to be able to use it. And the idea being with access control is that it complements the alarm.com for Business because the the business owner can provide electronic access to their employees and quickly, you know, target, if you will, certain access times for various employees just using a computer screen. And the employee can use their smartphone to, unlock a door. And so it's it's quite a big capability, but it is a new offering relatively speaking. So that's an area where we've had to train the dealers, and 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 commercialalarm.com for business is very well addressed by a lot of alarm.com for dealer dealers. It's just the access control is the new offering that took some take take take 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. 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, you know, around 86% plus, and then the hardware gross margins are in the, you know, the low 20% range. But, we 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 q one, hardware revenue was up, I think, over 80% year over year, and and a lot of that was driven by video. And, video is something where we, really believe that we have to provide, at least today, the video cameras based upon, you know, 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. So, ideally, over time, you know, we'd like to see hardware, you know, ideally less than 30%, but at the same time, video is complementing the the adoption of the security system and the smart property. So it is kind of a, a good news situation where, you know, more video ultimately leads to more SaaS and a higher, we think, lifetime value because 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. So we we're hopeful over the next, you know, 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. SaaS. And what was that number a year back? That's a good question. I don't have that right off the bat, but I would say I would just say, generally, commercial hardware and software has been running at a higher growth rate than residential. And let's say, on average, it's been growing at about 40% plus per year. So it'll give you some idea. Okay. Okay. Got it. And where do you think the 8% goes over time? Well, we think, you know, one 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. And you can imagine if you have, let's say, have a a franchisor or, you know, a a university with a 100 or 500 cameras, if you have the video analytics capability of monitoring those, those locations and having smart alerts that we think that'll provide a lot of value add. So we think, there's a lot of capability there for, the capabilities for commercial. We haven't really set necessarily a target, but I think given the growth and given the opportunity and given the tab, because you think about in North America alone, there's 4,000,000 properties that we, you know, we think it would qualify for their for our small business, alarm to comfort business. And then with OpenEye's cloud based solution, the TAM that I've seen there is multiple billions. I think it's, you know, 4,000,000,000 TAM or something like that is the opportunity. So, hopefully, over time, you know, we think commercial can continue to increase as a percent of revenue and percent of staff. Got it. Got it. Switching gears to the international opportunity, if you can give us an update there. So international has really been seeing you know, we've been seeing good growth there as we've added a number of new subscribers internationally through a number of dealers. So we've expanded the economies that we've been able to enter into. So now we have, I think, over 40 countries that we're in internationally. And the way we've been doing that is 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, you know, train them and then have them come up to speed on the alarm.com solution. So it's it's a it's a little bit more time consuming internationally. You've got different standards. You've gotta, you know, 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, and we signed up a number of new new dealers who are, you know, converting some legacy systems to, the interactive system. Now I will say that COVID certainly has slowed that down a bit, And so, you know, we have some delays with those, you know, new dealers actually rolling out, because of the shelter in place. But it's just a it's just a matter of a delay, not a you know, it's ultimately going to be implemented. Probably will be delayed, you know, till later next year or maybe late later this year, I should say, or early next year. But 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. So what we would hope is over, you know, 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, you know, 25 to 30% of our revenue. Got it. Got it. Switching gears to service providers, which are your as a b to b business model, they're they're they're they're customers at the end of the day. How would you evaluate, and how do you monitor the health of the service providers? So we have a range of service providers, you know, 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, you know, 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 and in fact, we connect and we, you know, we we have discussions with the service providers on a number of occasions and and have close relationships with them to see how they're doing. We look at our our receivables from the service providers on a regular basis. And if you look at our our DSOs, for example, at the March for q one, DSOs were forty nine days, which were flat to DSOs as of December, forty nine days. So, now q two will probably be a little bit higher because one thing we have done is we have informally, you know, given a little bit more grace period to our service providers to give them a little bit extra time to pay, you know, maybe fifteen days or so, just informally and not really press them. And so, you know, I think that's that's been helpful. But I would say that, generally, you know, the, 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. So there are some dealers that actually buy accounts from other dealers. And so 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 wanna keep, obviously, those that recurring revenue, but it helps to backstop the service providers. And so today, you know, we've we certainly have have have not lost a service provider. We've seen them continue to you know, some some do better than others, of course. But overall, I would say that, you know, 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 in the chat box, so feel free. So, Steve, switching gears to to some of the the numbers here. You you mentioned in the beginning of the conversation some of the assumptions underlying the 2020 revenue guide. Yes. But can you help us with some of the math here? If new 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. So what the 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 of the if you think about the, the stair step of the SaaS business grows on top of it. So for example, the SaaS subscribers we added in q four of last year only contributed, let's say, a few months of 02/2019, but they contribute all of '2 thousand and 12. So you can't just say, well, if you're at you know, if your business is down 30% gross adds, that means your SaaS is gonna go down for a couple of reasons. One, because of the way the stair step of the SaaS reoccurs, and you get the full benefit this year of the subscribers you added partially last year. And then of all, we said that, the business was down 30% at the low point. So that's a short period of time, and we've said we've guided based upon the recovery to the point where by q four, we would be at ninety five percent of gross ads compared to pre COVID. But again, because of the nature of the SAS business, it's highly predictable. Obviously, you know, the growth we've guided to is a little bit less than the guide pre COVID, and it's actually ninety nine percent for SAS of the pre COVID guide. And and that's because of the the SaaS model because of the recurring predictability of the model. Now that said, clearly, year's SaaS will be slower growth than we would have otherwise had had it not been to do the slowdown of COVID just because of the way that this is the way the SaaS grows. I think, you know, 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. But that's that's the reason why it's the way the business model you know, way the SaaS revenue stair steps on top of the previous subscribers added. Okay. Another interesting, trend in the numbers we noticed this quarter, q one was, the other it relates to the other segment, which is your energy business, your your your rental business, vacation rental business. So in q one, that business, other SaaS business, was down 2% year over year on what looks like tough comps, which means that the core SaaS business actually accelerated in q one to 15.9% versus 14.6 in q four, after it bottomed out in 12.6 in in q three. So what is driving this reacceleration in the core SaaS business when you look at the other segment? And if you can just also talk about the seasonality of of the other segment, which was a headwind in q one Yes. Should it expect to become a tailwind for the business for the remainder of the year? Yeah. So there was, one thing that occurred in the other segment, in q one. In February, 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 previous always been electrical. And I think what happened is that program did not get renewed by the regulators. The the utility wanted to continue with that program, but they had to get approval by the regulators. And I think given what's happened in California with everything else, and as you can imagine with PG and E and everything, I think their focus is on other areas. So that program, which was, you know, a 7 figure program a year ago, did not occur reoccur in in q one and likely won't reoccur. So that was a, headwind, if you will, in q one, but we don't at this point, we don't see any other headwinds. And in fact, we think based upon the, you know, the utilities that EnergyHub have signed up, we think it'll be a tailwind going forward. There is some seasonality that occurs with energy up in q four. Typically, we get the benefit of the energy savings in the summer months that contribute to the q four number, but that's really the only, seasonality for the, you know, for the other segment business from that perspective. And, I think that answers. Was there another part of your question? Yeah. The other part was when you adjust for that, the core, that business, like Yes. Oh, yeah. Yeah. Of course. Has been accelerating after bottoming in q three last year. So what's going under the covers here? Yeah. So a come come a combination of things. Again, it's the subscribers that we added last year that we got the full benefit of this year. And, you know, last year, we did have, you know, some, let's say, some hiccups, if you will. We have some time to time on the SaaS revenue. We weren't able to recognize all the SaaS revenue in q one, and, you know, we've kinda worked through that. And so it would the 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, you know, with the 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. So it's really mainly the addition of new subscribers across the company, both in commercial and and in residential, international that's really contributed to that. And, again, it's the way that Stairstep works with SaaS. You don't get the full benefit right away. Right? Because the subscribers you add in a quarter, you only have maybe half of a month and a half for the full effect of that. But then the following year, you get the full effect. So that's the way the model works. Got it. Got it. So we'll touch on a few of the growth drivers of the business. Just 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 set, etcetera, etcetera. You you mentioned the 40% drop in commercial. Just maybe help us tech rank them and and put all these growth levers in in context in in relation to each other. Yeah. I like this question too because it's kinda like, which child do you like the best? I love all my children. But but, no, it's a it's it's a great great question because there are a number of good growth drivers here, and it's hard to say which one is strength 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, you know, in terms of the end subscriber, but being able to get value added, information every day and and and value added alerts every day and what's happening with their system. But I would say all of those are really good growth drivers. And just generally, the way the company is focused on providing, you know, technology to expand the use of the, smart system, you know, with security being the hub of the smart property, we really think over the next ten years that, every property, you know, should be a it could be a smart property, either commercial or residential. And we think that we have the opportunity given our technology with our secure, with our dealer base to be able be the leader in that area. And we think security is a great platform to build off the small smart property. So we're continuing to invest in new technologies. And 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, you know, 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 even much easier for the, you know, for the end subscriber to use better technology for the dealer. Because, again, the dealers use our technology, and much of their, you know, back end to be able to manage their business in terms of what's happening with the with the with the, you know, installations, being able to easily do, remote remote diagnostics. So there's a lot of tools we provide the dealers as well. So it's really the focus on technology innovations to make the system, much more capable. We have time for one more question, and 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. So we definitely have a number of competitors. And internationally, it's different than it is in North America. I would say the the historical competitor has been Honeywell. They're really the legacy provider, mainly of the hardware and of the legacy, you know, landline security systems. Honeywell spun out Resideo, and so that's, I would say, really our key competitor now. There are some smaller competitors that, you know, have just maybe a 100,000 or so subscribers or less. Those are private companies that I'm not gonna name. But then there are you could say there are indirect competitors, for our dealers, although these tend to be more point solutions, what you call for DIY, where, you know, somebody might wanna put in a, thermostat. They might wanna put in the camera. Obviously, you know, there are some DIY providers out there that been advertising like crazy. I think what we've seen is it's a different consumer, different use case. If you have an apartment, you know, if you're not that worried about security, then you might wanna put in a DIY system. But if you if you have a vacation property, you have your home, you wanna be able to use your system, you wanna make sure it's gonna work every time because we really go to market and foremost focused on safety and security, and then we add on top of that all these smart home features. So our go to market is very much different than the DIY, which is more about simply simplicity and, you know, point solutions, I would say. And for some, you know, apartment owners and stuff, it's 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 and thanks, to everybody on the call for taking time today and and your interest in alarm.com. And, Nikolay, like, as we talked about at the beginning, I really hope next year we can do this safely in person in San Francisco. Yeah. Look look forward to that, Keith. And everybody, please stay safe and, and healthy. Thank you, everybody. Thank you. This concludes our presentation with alarm.com. Thank you.