J.P. Morgan 48th Annual Global Technology, Media & Communications Conference

May 12, 2020

Good morning, everyone, and welcome to the forty eighth Annual JPMorgan TNC Conference. My name is Tim Krubner. I'm a Managing Director with the Technology Investment Banking Group at JPMorgan. I'm excited to be joined today by alarm.com's longtime CFO, Steve Valenzuela. Steve, welcome and thanks for being with us today. Thanks, Tim. Thanks for having me and certainly wish it was under different circumstances. But it's great to join you today and certainly hope the next year we can be in person. Absolutely. Looking forward to that. So before we jump in, for those that are not as familiar, please just take us through the quick history of the company, a little bit about your unique go to market model, maybe a little bit about the core market and your competitive position in that market? Sure. Yes. Thanks, Tim. So before I begin, investors, just want to let you know that you can see our investor deck on the Investors section of our website. We've got a couple of good video testimonials on there as well, thorough overview of the company and also very importantly to us our safe harbor. So I've got to say that I would ask the investors to look at our safe harbor and this fireside chat is subject to our safe harbor as well. So with that out of the way, I'm happy to give you an overview of alarm.com. I'm excited to be able to share with you the history of alarm.com. And given the time, I'll make it a little bit short here, but Steve Trondeau founded the company back in 2000 when he was CTO of MicroStrategy and he was actually getting an alarm system installed by ADT. And he asked the installer, what happens if somebody cuts his wire you're putting up? And the answer was you have no alarm system. So alarm bells rang off, no pun intended with Steve being a technologist, but also realizing there's a lot of value in the data even when the alarm is not activated. So to make a long story short, Steve incubated alarm.com within MicroStrategy from 2000 to 02/2008, spun out of MicroStrategy in 02/2008. And then they really tried a DIY, they tried shipping systems out of their offices and it was just a very, very long process. And Steve and the team really hit on the idea that there's all these alarm dealers out there, service providers that we call them that are installing Plano legacy alarm systems. And so the inventions that alarm.com came up with, of all, that makes the alarm system cellular base with a cellular backup. So that if your phone line goes down, your alarm system still works. But then even more importantly is to make the system interactive. So you can actually interact with your alarm system outside of your home. Prior to alarm.com that feature was not available. So you would go home and punch in the keypad in the classic old alarm system. You couldn't interact with your alarm system outside of the home. And so that was the key invention that the team came up with. And right around 02/2008, 02/2009, if you recall, Apple came out with the iPhone and the App Store. Alarm.com's app was one of the apps in the App Store. So that was actually very good timing. And so the team continued to make improvements on that. Our system is all interactive, meaning you can interact with your alarm system outside of your home and many other features. So continuing with the timeline from 2008 to about 02/2001, the team started signing up all these service providers. It took about four years, then in about 02/2002, we got to 1,000,000 subscribers. So we really had to hit that inflection point, 1,000,000 subscribers. And then in 2014, we got the 2,000,000 subscribers. And again, having that dealer inflection point, having a certain number of dealers really got us that capability to be able to ramp up quickly. And then by 2015, we went public with about 4,000 subscribers. And today, we have about 6,800,000 subscribers and over 9,000 service providers. And these service providers are independent businesses. So they're independent businesses in terms of being large dealers like our largest is ADT and also being regional dealers and also very small businesses as well. So we go to market through the service providers, the dealers independent businesses. And the value proposition we provide is we provide the operating system for the smart home. So we provide the software, the technology, we host the services for the dealer. The dealer does the marketing, the servicing, the installation, the renewals, the customer support. When alarm goes off, it's the dealer's call center that actually responds to the alarm system. And so that's really the value proposition we provide. Again, we have about 6,800,000 subscribers today and over 9,000 service providers and we're a global company with operations internationally. Last year, international was about 3% of revenue. We think there's a big opportunity international. So that's probably a fairly good starting point for the overview. Great. Thank you, Steve. Let's jump into the topic of the day. So how has alarm.com and its dealers fared during the pandemic so far? Yes, it's been pretty incredible how quickly this pandemic has come upon us, right. And then we reported last Thursday our Q1 results and we had record results. What we saw is we had a continuation of the growth we achieved in 2019 in the January and February. March, when shelter in place occurred, we did start to see a slowdown in terms of new activations gross adds. We said on the call last week that at the low point, we got to about seventy percent of pre COVID installations. The good news is retention has remained where it is. So our subscribers are still keeping their systems. And what we've seen recently is actually an improvement off of that 70% gross adds in the last couple of weeks. And it kind of coincides with the releasing of the number of regions releasing the shelter in place. And so we've actually improved quite a bit off of that low point, if you will, 70% gross adds. And our dealers are quite resilient. I'm really impressed. We get a daily update from our sales team from different dealers or what they're seeing. Clearly, some dealers, their employees did not want to go into homes, some customers didn't want anybody coming to their homes. But our dealers have really, for the most part, out how to do remotants have worked with the subscribers to do remote upgrades and video cameras, how to be able to make sure that if they're going to the home, they obviously do a call with subscriber ahead of time, making sure no one is sick. The dealers have been able to get some PPE equipment for the technicians. And so it's kind of been all over the board. But when you have 9,000 service providers, and most of these are independent businesses, they figure out how to get things done. And so again, I've been very impressed with how resilient they've been in a challenging environment. And so it's encouraging to see the uptick in the gross adds in the last couple of weeks. And I think it really does coincide with the releasing of some of the economies and some of the geographies, if you will, with the shelter in place. That's great. And how should we think about any issues on the supply chain in terms of sourcing on hardware solutions? And how should we think about alarm.com from the perspective of hiring and the impact of the pandemic there? Yes. So in Q1, we actually had record hardware revenue, over 65% of our hardware revenue tied to video cameras. And so we actually have a very good supply chain process where we try to have at least two months of inventory on hand and a month on the water. Some of our finished goods do come from China. We did anticipate January, February with China really going through the COVID that there might be some supply disruptions. And so we did buy ahead and we actually reported about 85% year over year increase in hardware revenue, which was phenomenal, quite over expectations. Now we did say on the call last Thursday that we do expect hardware revenue to come down significantly in the second quarter. Again, as things started to tickle in March with COVID, we have seen a slowdown there. And we do think that perhaps part of Q1's hardware revenue was some pull forward from dealers as well stocking up in advance. But we've been fortunate that for the most part, our supply chain has been considered an essential service and has been continued to operate, maybe not at the full capacity as prior to pre COVID, we do have some finished goods locations and assembly finished assembly locations in The U. S. And they've continued to operate. So we've been quite fortunate that we've not seen a large disruption in our supply chain. Great. And on the hiring front, how do you think about that? Are you Yes, that's actually a good point. We've actually we are very much an R and D company, We're really focused on software development technology. We spend almost 25% of our revenue in R and D. That's really the value add we provide our service providers, our dealers that we want them to have the best technology available and always be at the state of the art. And so we've actually continued our hiring for R and D and we've actually been able to hire positions, key engineering positions we weren't able to fill pre COVID as employees have become available. We've continued with our intern program. We have over 40 interns starting. We're going to start them initially virtually. So we've not slowed down on hiring at all. As a matter of fact, we've probably accelerated from what we were initially thinking for R and D. Now we have slowed down in G and A, of course. Sales, we're still hiring sales for OpenEye in Spokane, Washington, the acquisition we did in the fourth quarter. They have a number of sales positions. We think there's a big opportunity there. But we've been very fortunate to actually be quite successful in our hiring program. That's great. That's great. So maybe we move on to financial performance. So one of the most attractive things about this business has always been high quality SaaS revenue. So talk to me a little bit about some of the key attributes around that revenue in terms of margin, retention rates, lifetime value, etcetera? Yes. So we're very much a SaaS business and the hardware really just enables the SaaS. So we price our hardware at around the 20% margin really to drive SaaS. Our goal always is to drive that recurring revenue. About 70% to 65% to 70% of our revenue is SaaS. It's recurring. It's about at 86.5% gross margins. As a matter of fact, last quarter, the gross margin picked up 200 basis points as we've been able to get some efficiencies in our operations. So 86%, 86.5% gross margin for SaaS, highly recurring, highly predictable. As a matter of fact, we were able to give guidance for Q2 and for the year based upon the fact that we already have a lot of our revenue, if you will, essentially recurring coming in on a SaaS basis, because we know what subscribers we added, like the subscribers we added at the end of last year really contribute to revenue this year. And so we have a very predictable model from that perspective. And the fact that retention rates actually retention rates have been between 9294% in the past. This last quarter, they were 93%, which is only about 20 basis points lower than the prior quarter, which was more of a rounding error. But we've continued to see very good retention levels in our business. And I think the the need for security is a fundamental need for people. They want to be safe. Businesses want to be safe, even when they're not at their business, they want to make sure their properties are secured. So we've continued to see very good retention and really not seen any significant churn whatsoever. Yes, that's great. So you brought up the topic of guidance. I thought it was interesting you held on to your full year, your quarterly guidance, a lot of your peers have been pulling guidance. You're one of the few companies that has that's a pure cloud business, but has a on premise implementation aspect to it. Help me think through kind of what went into that decision and how you think about guidance. Can you talk a little bit about the visibility? I'd love to hear more about that. Yes, I think we had quite a big discussion on this, as you can imagine with the Board as to should we give guidance, shouldn't we? From our perspective, we think it would have been disingenuous to our investors to take quite honestly to say we have a predictable model, which we do, highly recurring model and then not give guidance. It could have been an easy thing to do honestly. Everybody not everybody, lot companies are not giving guidance. Now I'm not sure if the recurring revenue companies, I think number of them are giving guidance. So I think it's fairly balanced. But based upon what we saw and what we modeled, we modeled conservatism in model. We factored in obviously some improvement off of that 70% low point we saw in terms of gross adds in March. And we felt comfortable with that given the last few weeks of uptick that we've seen that hopefully that continues. So far, it still continues to tick up. I will say that if there is a wave, if you will, in the fall, then you can't predict that. So we did caveat our guidance to say, look, this is what we see today. We are expecting that by year end, we'll be at about a 95% of normal activations. But the thing about the model when you have a recurring business model like ours, it's a very predictable, very recurring. So it's really hard to move the needle one way or the other to change it too much because a lot of what we're going to achieve this year, we've already added those subscribers in the and last year. So it's fairly predictable as long as we continue to maintain that retention, which we have so far. But yes, it was a very, very important discussion. Again, we have taken the guidance offer. And in fact, we guided SaaS for the year at 99 percent of our pre COVID guide. Feel maybe talk a little bit about in this environment cash collection. So what have you seen? What do you expect to see in terms of any changes on the cash collection and cash flow side? Yes. So we have a range of dealers anywhere from small dealers to again ADT. And so we have tried to be flexible, allow a little bit extra time for the dealers. We want to help them in this difficult time. And so in some cases, we've given them we've not pushed, if you will, we haven't done a broad program, but our DSOs in Q1 were forty nine days flat to Q4. So they're same DSO levels. Now I will say in Q2, they'll probably tick up a little bit, but we watch our receivables very closely. As a matter of fact, over 90 of our receivables even recently are current or within thirty days. And so we've been getting a little bit of a little bit more grace period for dealers to pay. Most dealers have also been paying on time. And a number of our smaller dealers actually have taken advantage of the PPE PPP, I should say, and been able to actually get some government funding, which has been helpful in terms of being able to maintain their employees. So that's been helpful as well. But we watch receivables carefully. We have a good cash flow generation business, good cash flow model. And so we feel very good about our very strong balance sheet, very good collection history, DSOs. Yes, that's great. Now, I believe you reported that you pulled down $50,000,000 on the revolver. That's right. We've seen a lot of that across tech. Help me understand, is that kind of conservatism and safety obviously or cash flow positive model? Or is that a kind of a function of what you're talking about before in terms of helping out the dealers on kind of timing? Yes, it's really we did that at the right at kind of the beginning of COVID shutdown and we talked to our banking syndicate. And the feedback from them was like, look, you guys don't need this, but everybody else, some of our other clients are pulling down their revolvers. So in the and we talked to the Board and we decided, there's going to be we of we have a good cash flow business, we're probably going to generate 40,000,000 to $50,000,000 of free cash flow this year. But there's going to be probably some opportunities here to really do some M and A at some point possibly if the right opportunities come along. And so it was a combination of realizing that we didn't know what was going to happen with liquidity. We wanted to be able to pull that down. The cost was very low. As you know, interest rates are very low right now. And so and the term is on that revolver doesn't expire till October 2022. So we felt it was the right thing to do to put it on the balance sheet. And we think that we have the opportunity given our strong balance sheet and our cash flow generation to emerge out of this an even stronger company with some good perhaps tuck in M and A opportunities. We don't necessarily have anything planned right now, but we're watching carefully. We're going to be very careful. We have done a few acquisitions. As a matter of fact, last quarter in Q1, we announced that we spent about $4,400,000 on a couple of small acquisitions. And last year, we acquired OpenEye where we spent about a little bit more than $60,000,000 all cash. And so we felt that for our investors, we've only done an IPO, we've not done a convert, we've not done a secondary. So we felt putting the additional debt, which is quite honestly right now, we're a little bit more than one times EBITDA, which is fairly low debt ratio, I would say very low. And so we felt that that was a way to have some extra optionality, if you will, without diluting the investors. Yes. So I want to come back to the open eye and door court topics. But before we do that, you've initiated for the time a share buyback. Talk to me a little bit about your thoughts around that buyback and what your plans are in the future as it pertains to that buyback? Yes, exactly. And the timing of that also was around the timing of when we pulled down the $50,000,000 So there is a possibility we at the right point, we may continue to do more buybacks. The Board authorized a $75,000,000 share buyback in about November of twenty eighteen. So the program currently goes through November of twenty twenty. And so we put that in place, if there was going to be some out of normal situation occur. We obviously didn't know at that point in time that what was going to happen with COVID. So we actually activated that given the strange activity we saw occurring in the stock during COVID and felt that the levels got really too low. And so we'll keep that optionality available to us. And like I said, we spent about $5,000,000 of the $75,000,000 authorized. So we still have about $70,000,000 available. Not saying we're going to necessarily use it, but it's there. And we'll see how things progress. Great. So maybe we shift the topic to video. So we talked about video before the explosive growth that you've seen in that segment. And for obvious reasons, because I think we can all relate to that. It's been a key initiative for the better part of the year now. Your hardware sales have been significantly up, which you've attributed again to the sale of the video gamers. Talk to us a little bit about the software analytics platform that sits behind that, right? Because there's obviously a hardware aspect to that, but the value prop is very tied to the software that you've built around it. So talk to us a little bit about that and specifically the economics part as well. Yes, no, that's a good point. So we acquired Optic Video in January actually of twenty seventeen, team in Reston, Virginia here not too far from our headquarters and brought the team on board. They were doing a lot of work for the government. As a matter of fact, on the investor deck, there's one of the key engineers there who talks about object video. But they were doing a lot of networking and AI for the government. And so we repurpose them for video because we really feel that having a video system that is intelligent and provide a lot of value add. And so we've actually complemented that with a lot more software engineers and key in video analytics. And so about a little bit more than a year ago, we released our AR video analytics platform that really allows the subscriber to be able to have smart alerts. And we've heard from subscribers that their alerts per day have gone from like sixty fifty to 60 alerts per day down to seven or five or seven. And so it's made the system a lot smarter. The system can recognize people, places people, animals and vehicles. And so my key my favorite feature is to be able to have your sprinkler systems and lights turn on in your backyard when there's an animal in your backyard. There's a lot of other good features for commercial too. So you can commercial business can use that to detect if there's somebody loitering in the backyard I'm sorry, in the back of their establishment to be able to do eventually be able to do line counting to be able to tell if they send need to send more employees to one of their other restaurants, if you will, in the area, if they have a longer wait there. So there's a lot of capability with video analytics and we're still at the very beginning. But what we've seen is a pretty significant uptick in video analytic adoption. And the way the financials were the metrics is that typically the ARPU that we charge the dealer and we've talked about is an average in the average of $5.5 If you have video, then we're probably charging the dealer an average closer to $6 And then video analytics, we charge the dealer additional $0.80 to $1 And then of course, the dealer charges this is per month, this is the ARPU. Then the dealer, of course, charges the subscriber, either the residential customer anywhere from, let's say, 40 per month to $55 to $60 per month, depending upon the system. For commercial, ARPU we charge the dealer is about $10 or more depending upon the system and then they're able to charge the commercial business closer to $100 So it adds a lot of capability for the service providers to be able to add more value to the end subscriber, for the service provider to make a higher revenue. And even as importantly, it really drives retention, because the value add you get from your system of being able to check-in and get smart alerts. And if you have a system with a lot of video, it can be kind of overwhelming if you don't have smart alerts because you get a lot of alerts. And so it really provides a capability that drives a lot of retention and drives a lot of value add to the end subscribers. So we're just at the beginning. We think there's a lot of capability in video analytics in recognition both for residential and for commercial customers. Yes. So let's dive a little deeper on that. So help us understand how should we think about penetration of, I guess, one video within your installed base, but the number two software analytics within the video installed base, the camera installed base? Yes. So last time we updated this, we said in a typical quarter, more than 35% of those new subscribers have video. Of those about 40% to 50% opt for video analytics. So that's new subscribers in a quarter. Now we don't update it every quarter. I think that was the last time was Q4. We're probably doing a little bit better than that in Q1. But also what's interesting too is existing subscribers on average in a quarter, existing subscribers account for 15% to 20% of our camera sales. So they're upgrading their systems in a quarter. Overall, if you look at overall of our 6,800,000 subscribers, less than 20% of them have video today of the overall population. So there's still a lot of upside in terms of penetration to the subscriber base. Got it. Great. Okay. So next topic I want to cover today here is the commercial business. So maybe start off, can you talk to us a little bit about kind of how should we think about the mix of the business between residential and commercial broadly? Yes. So we actually started the Lunda Comfort business about a year and a half ago. And today, prior to that, there were some service providers providing the residential system to small businesses like a local Wendy's or insurance or local coffee shops. And so one of the comfort business was really started with the gear with goal of really providing unique features that a business requires such as auto alarming at night, sometimes employees lead and they can put on the alarm. So auto alarms for the business. But today about less than 8% of our SaaS revenue comes from commercial. That's SaaS revenue, right. And so most of our revenue is still coming from residential customers. We did acquire OpenEye in the fourth quarter of twenty nineteen last year. We said that their revenue is going to be about $40,000,000 for 2020. Most of that is hardware revenue because in the prior to them being acquired, they were a private company, they were optimizing for cash upfront. And so they were selling their system, which is cloud based as a term license, if you will. And so we decided to count that revenue as hardware and other revenue. We've now worked with OpenEye to come out with a SaaS offering, where over time, we expect the SaaS revenue from OpenEye to increase. If you look at in Q4, they contributed about $100,000 to our SaaS revenue. In Q1 of twenty twenty, they contributed about $200,000 So very small SaaS revenue today. For the year, we think their SaaS revenue contribution will be a little bit less than $1,000,000 But over the next few years, we do think that they'll start to contribute more to our SaaS revenue, given that we've actually repurposed, if you will, their offering and come out with versions that are that we can account as a SaaS offering. Yes. So maybe double clicking on that a little bit. So help me understand kind of what those factors are that play into converting that revenue to SaaS? So how does that play out over time? Yes. So the system has to be set up and has to be priced in a way so that it's counted as a subscription based model versus the term license. And so this will apply more to new deals. Now some existing customers will still want the term license. And so OpenEye is not necessarily going to go back and change those terms. But we need to be able to account for it on a SaaS basis as a subscription model instead of an upfront payment and upfront in a term license. So it needs to be a subscription, not a term license as has been the legacy system that OpenEye has provided. Again, it's going to be a small number this year for SaaS less than $1,000,000 but we think that there's opportunity going forward. And we're excited about the OpenEye opportunity. They provide us a great entry into the enterprise. So prior to OpenEye, the Alumni Comfort business was really geared towards small business, which is still good market, 4,000,000 to 5,000,000 potential properties for small business, but OpenEye expands us into the enterprise and some of their customers are pretty well known names, Whataburger, Gonzaga University. There's other customers that have theme parks we can't name that are big customers and franchisees. And so they sell into they have over 400 dealers, if you will, integrators that sell into franchisors and sell into large restaurant chains and such. And so we think there's a good opportunity there. And there's only about a 15 overlap between our dealers alarm.com dealers and OpenEye dealers. So a complement to the business. So the OpenEye deal is interesting because as you referenced before, you are undoubtedly a R and D organization, you have not been active in M and A historically. What is it that you talked about the business a little bit, but kind of help us through the thinking of what caused you to number one, build versus buy and number two, kind of get comfortable with an acquisition. I'd love to understand a little bit about just kind of what you found subsequent to buying the business, how that impacts how you think about M and A going forward? Yes. of all, one of the key features of key things we look at is cultural fit and make sure the management team is consistent with our focus on customer support. We really focus on making sure we're providing our dealers the best customer support. OpenEye was actually not for sale. They had been privately funded, self funded. Rick Sheppard, the Founder and CEO of the company had been running the company from the beginning, not taking any VC money. And they were looking to raise some money. And so we heard about them and we actually approached them. Moving found was a company that had quite honestly not invested as much because they didn't have the they were again self funded. And so we saw an opportunity here where their cultural aspect, focus on customer service complemented and very much consistent with our approach to the business. Again, we talked to some of our dealers, they had a very good reputation in the marketplace. And so we really saw an opportunity here of bringing OpenEye on board. What OpenEye and Rick Shepherd and the team saw was an opportunity to accelerate their business. So instead of thinking of it as selling out, they were thinking of it's joining up. And so Rick really sees the opportunity to accelerate his business being part of alarm.com. And I'm happy to say that we've retained Rick and all the management team of OpenEye as part of alarm.com. And kind of the way Steve Trundle founded the company incubating within MicroStrategy, Steve applies that to businesses we acquire. So that Rick still has they still have the OpenEye name. They still have their own identity. They have their own sales teams, but they leverage our R and D expertise. They leverage our G and A infrastructure, our cash, of course. And so it's really a great way to effectively still run a small business, if you will, within a larger company. And so we've applied that to OpenEye just like we did with EnergyHub and PointCentral, the other businesses we've acquired over the years. Yes. And help us understand a little bit just the pace of integration and where you are on OpenEye and DoorPort in terms of integration and how should we think about impact, I guess, particularly on OpenEye to margin contribution going forward? Yes. So we actually from a G and A point of view, we've integrated OpenEye. So we've taken over the payroll, we've taken over we've added them to our HR system. And but for the most part, they're going to do their own selling. The R and D team is already working with OpenEye. R and D team at alarm.com in terms of analytics, which we think, by the way, is a big opportunity of being able to take our analytics engine and incorporate that into OpenEye solution. So the R and D teams are working together. But again, we kind of do a soft, if you will, integration. We want them to still have their own identity. We want them to benefit from the back end of alarm.com, but be able to still be nimble and be quick and move fast. From a margin perspective, they actually help our gross margin a bit. Their gross margin or hardware is closer to around 25%. And so this last quarter, our gross margin overall was around 23, whereas a year ago, it was around between 1820%. So their gross margin is a little bit higher than our gross margin on hardware. And then of course, as they add more SaaS, their SaaS margins are equivalent to our SaaS margins. Great, great, great, great. Well, we've got about thirty seconds left and they're keeping us to a tight schedule here. But I guess, maybe last question here is international. I'd love just to understand kind of total opportunity and recent trends in the international business, what should we expect there? Yes. So that's a good point. We signed a number of new dealers last year internationally that have existing legacy subscribers that they'll be adding this year, which we think is going to contribute to growth. Now, I will say that we did see more of a shutdown internationally. So, international is more of a decline, but that has started to come back as well. But there's probably more of an impact from the shutdown internationally. We still think international can be 20% to 30% of our revenue in the future over the long term. That's great. Well, our time is up, Steve. I appreciate you joining us today. As always, it's a pleasure. And congratulations on your continued success. And thanks for having us. Thanks very much. Have a good day.