We're 8:40 A.M, so ready to kick off this morning. Mike Funk from BofA , midcap software analyst. Thank you all for being here with us this morning. Really happy to have Steve Valenzuela from Alarm.com with us as well. Steve, thank you again for being here.
Great to be here. Thanks for having us.
I wanted to, you know, kind of open with a question, just to highlight maybe the differentiation of Alarm.com relative to other enterprise software companies, because the last 12 months, we've been hearing a lot about, you know, enterprise IT budget compression, you know, sales cycle elongation. Alarm.com is unique. Your primary market is actually the residential security market.
That's right.
so not facing the same macro headwinds. Maybe just kind of give us a baseline and, you know, walk us through the Alarm.com model, and maybe even just bullet point the last quarter or two of results and the trends that you have been seeing.
Right.
The differentiation.
Sure. Yeah, thanks, Mike. Alarm.com has a recurring SaaS model that we provide a SaaS operating system. I like to call it the operating system because we go to market through over 11,000, what we call service providers. These are independent dealers who every day are out there. They're doing the selling, they're doing the installation. Alarm.com is providing them the software that we host at our data centers, and we actually manage that data center for those service providers. We have 11,000+ service providers, over 9 million in subscribers. About 8 million of those subscribers are domestic residential subscribers. About a half a million are international, and about half a million are commercial. When you think about the Alarm.com model, we're a B2B2C business, highly recurring SaaS model.
What we do is we charge, for residential, for example, to give you a sense of the model, we charge the service provider a monthly recurring fee, the ARPU, based upon the system that the end subscriber has. It can vary anywhere from a base system, interactive system, where they might just have, you know, the security system, they might have a thermostat. For that base system, we might charge the service provider $5 per month. For a complete system with interactive AI, with cameras, with thermostats, we might charge the service provider $8 per month. The service provider, in turn, charges the residential customer anywhere from $35-$85 per month. The sweet spot is typically around $50, $55 per month. That's residential. Again, that's where the company started many years ago.
About five years ago, we entered into the commercial market. We started it with SMB, and that did very well, and we took our residential model, essentially, and, or residential system, we worked with small restaurants in the neighborhood, we worked with coffee shops and, modified our system to really provide the same kind of security system for a commercial business with some nuances. For example, auto alarming at nighttime, because a lot of businesses found their employees would not turn on the alarm when they left. A number of features like that. For commercial, the opportunity is quite significant. It's new to us.
For commercial, we get a higher ARPU, anywhere from $10-$20 per month per subscriber, and the service provider charges up to $100 or more per month. That's for the SMB portion of commercial. About three years ago, we acquired a company called OpenEye that got us into the enterprise. This is similar to enterprise software. It's still a highly recurring SaaS model, but here we're selling to, like, think large franchisors, think of theme parks in Disney in Florida, without naming the customer. These are large companies that are really looking at putting in maybe thousands of cameras. That business has done very well for us. It's grown about 25% year-over-year.
When we acquired the business three years ago, it was more of a term license model, because they were a startup company, they were not, you know, public, they didn't have as much cash, and so they were charging more on a term license business basis. We converted that model to a SaaS model. Last quarter, for example, that business generated $2.4 million in SaaS revenue for the quarter, which is up 100% year-over-year. We're seeing good growth there. One of the things that's really helped us over the last four years, five years, actually, and has kind of been unknown or not highly publicized, and now it's all the rage, is AI.
We actually acquired a company in Reston, Virginia, that was doing AI work for the government in January 2017, called ObjectVideo. We took that, those video analytics team, it's about 20 PhDs in video analytics. We supplemented that team, we came out with our AI system, which really provides smart alerts, provides smart features, so be able to distinguish between a person, animal, and a vehicle. For example, for residential customers, you could set smart alerts, you could set up, you know, how often you want the alerts, where you want the alerts. For commercial customers, we've adapted that as well to provide a lot of key features, like line counting. Imagine if you have, you know, four or five Chick-fil-A's in an area, which line, which drive-through is getting the longer and longer wait times?
You can move employees to that location because your AI system is providing you that indication, that information. Alarm.com is expanding that team. We actually just recently acquired a company called Vintra that actually, I think, is based in Redwood City, California, with employees in Spain, that have a lot of IP related to AI for commercial. A lot of capabilities to be able to do a lot of different things for commercial. Imagine if you have thousands of cameras and you have a school, and you have one person monitoring these cameras. If you have smart alert capabilities, and you have someone who's the AI system can tell if there's movement that isn't normal and can track that person and provide smart alerts, imagine the value of that.
We're continuing to invest in AI. That's a big area for us. Think of Alarm.com as a very diversified business that started in residential, expanded to commercial, added AI, added video. You know, this last year, we did was $840 million in revenue, $147 million in EBITDA. A very profitable, very cash flow profitable business, highly reoccurring. It's not the kind of business you're gonna wake up one morning and there's gonna be a lot of change in the guidance because it's very predictable. It's not like long sales cycles. I would say, though, that the commercial enterprise segment does have longer sales cycles because you're dealing with customers who are looking at putting in thousands of cameras and thinking about a, you know, average life of 10+ years.
In the residential side, it's actually faster sales cycles, but still the lifetime there is about eight to 10 years as well. High recurring, high renewal rate. Last quarter, we reported renewal rate of 93%. It's been around 94%-93% for the last four or five years, very consistent. I think that's probably good.
No, that was a great review, Steve. I think one of the reason we do like the stock is the recurring nature of the revenue stream.
Yes.
You know, less macro sensitive than other software companies. You touched briefly on, you know, some of the growth drivers. You named a few, right?
Yeah.
You know, whether it is, you know, thermostat or, you know, or video or some of the AI-related products. Can you walk us through the growth levers for the business, whether it is, you know, incremental penetration of the TAM-
Yeah.
Right? you know, new products like video, you know, home monitoring, how important is commercial for driving top-line growth?
Yeah, those are all very good points. Commercial is very, very important to us 'cause it's a, it's a relatively new area. One of the things interesting about commercial is the TAM is very large.
Mm-hmm.
It's about $4 billion-$5 billion in the U.S., about the same internationally, and it's fairly under-penetrated for what Alarm.com does. Alarm.com invented the interactive security system. Prior to Alarm.com, you had a land-based security system. You would come home, punch in your keypad, and that was your security system, and if somebody cut the landline, you would have no security system.
I remember that, yeah.
We invented the radio module, which made the system cellular-based. Based on being able to have that cellular connectivity, that provides a lot of features that we can actually monetize. One of the things we've done over the years is we've come out with new features, new capabilities where we actually charge more. Again, the example, you know, where a base system, like a base commercial system, you know, we would charge the end subscriber. We would charge the service provider $100. We also have access control, where we charge about $4 per door. You can imagine some companies, you know, can have multiple doors or maybe even 100 doors. That business is relatively new, so that's a growth driver for us. That's part of the commercial segment.
Again, commercial, TAM, very large. A lot of commercial customers actually have security systems that are not the interactive one, that they're a legacy one, that they're converting to interactive, because a lot of insurance companies require the commercial business to have a security system. Most of those are, again, the legacy, not the interactive that Alarm.com provides. We're benefiting both from the overall growth of the market for commercial, as well as customers converting to interactive security systems. Let's face it, the world isn't getting any safer. Businesses need intelligent security systems, not only to, you know, see what's happened, but hopefully to actually prevent things occurring that are not good.
Mm-hmm.
Bad things from occurring. The opportunity commercial is large. The opportunity internationally is also large, so that's another growth driver for us. We got into international about five years ago as well, and right now, today, international is at only about 4% of our revenue, but it's growing about 25%-30% per year. It's also growing.
Mm.
-than North American residential. we're going to market internationally, similar to how we go to market in the US and North America, through identifying the service providers in those countries. Some of them are coming to us and saying, "Look, we have these installed base of legacy systems, we're looking at a make versus buy, instead of us trying to develop our interactive security system, we're gonna work with Alarm.com to convert those subscribers to interactive and be able to retain those subscribers.
Is penetration of professionally monitored residential, is it lower internationally than U.S.?
Yes, it's lower here.
Why is that? Is it cultural or technology differences? Why is it lower internationally?
Yeah, it's a good point. Yeah, some of it has to do with the cellular networks. Again, in the different countries, we have to work with, like Vodafone.
Mm-hmm.
Orange and different cellular networks. Some of it has to do with the technology, some of it has to do with the privacy standards, which are much, you know, higher in some cases internationally. So we've had to overcome that in a number of various countries by coming out with, you know, our own radio modules unique to that country, converting it to cellular-
The spectrum's different.
The spectrum is different.
Yeah.
Different relationships.
Mm-hmm.
-each country, and so it's, you know, it's been a process. Now I think we're in over 60 countries, and so we're, you know, we're starting to see that growth, but it does take longer internationally. One thing that is interesting, and I haven't actually looked at this very closely, but if you look at the growth curve of Alarm.com residential, in 2012 and 2013, we had, like, 1 million subscribers, and then it, I think it was around 2013, we hit 2 million, and we kind of hit the inflection point. We haven't hit the inflection point yet on international, but I think if you overlaid those growth curves, I think international's probably ahead in terms of the life cycle from when we started compared to residential North America. I think that's encouraging.
It's still a ways off. Don't wanna make any commitments that it's all of a sudden gonna go to 25%-30% in the next year. With that, we think the opportunity is, you know, for international to represent about 25%-30% of our revenue at some point. It's 4% today, 3% a year ago, so it is growing faster.
The 25%-30% of revenue, I mean, that assumes, I guess, what, for penetration internationally? Like, similar to the U.S. or below U.S. levels?
It's a good point because, again, internationally, there are a number of legacy providers out there that don't have interactive. The question will be: What penetration? What will be the adoption? We have to also have some technology, a communicator, and in fact, we just acquired a company in Poland called EBS, that we're working with an international communicator that we think will accelerate the international adoption. Because of the technology, you have to have this communicator that actually helps to have those international service providers be able to quickly adopt Alarm.com.
Mm-hmm.
It will be interesting to see how quickly that learning curve, that adoption is. It can potentially be faster, because again, these, you know, service providers in various countries, some of them have millions of subscribers on their legacy system. The opportunity for us, by having the right communicator, right technology, the right cellular relationships, allows us to help that service provider convert their subscribers to interactive. The question would be: Why would they do that? Why wouldn't they just try to do it themselves? Part of it is that they're trying to keep their subscribers, and everybody is hearing about smart home, smart home. The service provider knows, for them to keep their customers, they've got to adapt, and they've got to adapt quickly.
you know, a number of years ago, there was a whole thing about smart home, and is that really happening? smart home is definitely happening, not just in North America, but also internationally.
Sure. No, makes sense. I think another growth driver we've talked about is video and video attach rate...
Yes.
Right?
Yep.
I know you mentioned ARPU earlier. You know, video is.
Yep.
-to ARPU. You know, can you walk us through where we are today with video penetration, video attach rates? Third part of the question would be that when people generally add video, is it existing customers adding video when they upgrade, or is it driven more by, say, home sales and moves in the initial installation?
Yep. Video definitely is a very good driver for us 'cause we charge more for video. If a end subscriber has video, we'll charge the service provider $1 or more for that end subscriber. If they have video analytics, we'll charge another $1 or $2. That's how we get from the, a $5-$8 per month that we charge the service provider. In terms of the adoption of video, this last quarter, the video attachment rate was around 46%. A year ago, it was in the low 40s. What's interesting, too, is of that 46% of new subscribers that got video, 98% of them got video analytics, which makes sense because video analytics is, you know, the AI system that really gives you smart alerts, smart capabilities.
You know, we see that video adoption continuing to increase. For commercial, the video attachment rate is actually higher. You can imagine for commercial, they have to have video. We've recently just taken our video analytics team and worked with our enterprise commercial team to add AI capabilities to the commercial enterprise segment, which is relatively new. We think there's a lot of opportunity there. We've also recently just announced that we will start supporting third-party cameras for commercial. The reason that's important is because, if you think about, you know, a large business, they may have, you know, hundreds of thousands of dollars installed base of cameras, and they don't wanna have to throw those out.
No, of course not.
By us being able to... We want the SaaS. You know, the hardware is interesting, but we make a low margin on the hardware. We really want that recurring SaaS. By being able to support the third-party cameras, we could get faster adoption from commercial customers and save them money, and they can become subscribers of Alarm.com much faster.
Okay.
We get that recurring revenue.
No, it's a good point. I wanna talk about the competitive environment. You know, I know at least a year or two ago, the ADT relationship was top of mind, as a former partnership with Google, correct?
Yep.
You know, to develop home monitoring security in partnership with them. Maybe just, you know, refresh us on the relationship with ADT.
Yep.
How we should think about that going forward, and then just the broader competitive environment and, you know, who you're seeing, who's most competitive...
Yep.
Why you have a right to win.
Yep. I'll start with the competitive side.
Mm-hmm.
We're kind of like Switzerland, right? When you look at all the different service providers, ADT, Brink's, CPI Security, and 11,000 others, we're their operating system, they all compete with each other. We don't compete with ADT. You know, they're our customer. We do compete with Resideo, which was spun out of Honeywell. They're really our main competitor for the service providers. There was also Vivint, which is now acquired by NRG. That was kind of a competitor, more of a competitor of ADT and our service providers. When you look at the competitive environment overall, you had Amazon acquire Ring a number of years ago.
Yep.
Right? We, honestly, we haven't seen any impact from that, really. Maybe fewer doorbell, doorbells sold, doorbell cameras sold, but other than that, there's been no impact in terms of service providers, losing service providers. The one thing that did occur is a good customer of ours, ADT, which is about 15% of our revenue, did enter into an agreement with Google about three years ago.
Mm-hmm.
-which is, you know, very public, where Google invested half a billion dollars plus in ADT. The good news is we have a great relationship with ADT. They're a good customer of ours. We actually entered into that relationship with ADT back in 2017, when we acquired the Icontrol business. That was a company based in Silicon Valley that was providing the Pulse network for ADT, which was effectively the interactive system competing with Alarm.com.
Mm-hmm.
We acquired the business. ADT was very supportive of Alarm.com acquiring that business because the Icontrol business was not keeping up with Alarm.com. We then spent a couple of years with ADT, taking our solution and adapting it for ADT. It's still our, what we call our Falcor operating system technology, but it's has nuances for ADT. That's called Command and Control. ADT is installing that and selling that. The agreement with ADT is when they come out with what they call ADT+ for professional install, ADT will pay us a license fee for every subscriber that goes on ADT+. We will continue to operate and manage those subscribers that are on ADT Command and Control and Pulse for their natural life, which is 8-10 years.
It's a long agreement, you know, recurring revenue stream. We'll sell less hardware, of course, because Google Nest.
Mm-hmm
... providing hardware for ADT, which, you know, again, we don't make much, margin on hardware for residential. We, you know, we feel good about the relationship.
so the initial knee-jerk market reaction that, you know, ADT was gonna, you know, cut the cord and go to zero overnight.
That's right.
completely misplaced.
That's not going to happen.
Yeah. Your point about the ongoing relationship.
Yeah. Yeah.
you know, very much an annuity stream.
Yes
from that relationship.
Yes.
That's really the fact of the matter, right?
That's exactly right.
Okay.
I think it's important to point out, this is also public, but three years ago, when the relationship was announced, the intention, ADT intended to come out with the ADT+, which is for the professional install, because there's also...
Mm-hmm
a DIY version, which we're not involved with. That was supposed to come out at the beginning of 2023. That was pushed back to the second quarter of 2023. I think the latest is that ADT has publicly said on their call that now it's coming out in the fourth quarter of 2023. There have been some delays. I mean, what we do, if you think about Alarm.com, for 20 years, we've been developing and modifying our security system and third-party integrations. It's very complex. You've got all these different-
Mm-hmm
... control panels you've got to interact with. You've got all the, like, ledge, Schlage locks, Lutron lights, garage door openers, so many different interactive, you know, APIs we've had to work with to interact with these third-party devices, who we don't make all the hardware. Matter of fact, the radio module we invented, we've now licensed that to control panel manufacturers. Because if you typically look at a, you know, a security system, there's typically a control panel on your wall, and nowadays, they have a camera on there. We don't make that.
Mm-hmm.
But we make the radio module. We've licensed that in the control panel. There's third-party devices that sensors, even thermostats that we interact with, that we don't need to provide that hardware. We do provide hardware for the residential customers, for cameras, mainly.
Mm-hmm
... and also some for commercial because of the AI system and the capabilities that that provides. Again, the margin on hardware typically is in the mid, you know, 20%-25% range for residential. For commercial, it's closer to 35%-40% range. On the SaaS, the recurring revenue, what I like to call the gift that keeps on giving, because it's 85%-86% margin.
Mm-hmm
... that's really our focus, is that recurring revenue.
Sure.
We try to price our hardware as low as possible and reduce the barriers to entry, barriers to customers to buying, to be able to allow the customer to become a subscriber, because we know once they become a subscriber, they're a subscriber anywhere from eight to 10 years, typically.
Sure. lifetime value is very high.
Very high, very high.
Willing to sell a little margin.
I think I did that one time.
Yeah
... it was 6 to 1 or something.
Yeah.
I haven't done it recently, so it may be a little different, but.
Probably still in the same range, I would think.
Probably still the same.
You know, competitive environment, still want to talk about that. DIY has grown in interest and prevalence in the last several years. Is DIY a direct competitor to your business? Are you seeing market share loss to DIY?
I think, it's not a direct competitor, and it's not mutually exclusive.
Mm-hmm.
Our service providers will go into some homes, and they might have a Nest thermostat, or they might have a Ring doorbell, but they still want a complete security system. For our business, for the middle to upper income subscriber, for residential, it's generally not something. You know, they're not looking at spending their weekends installing a DIY system.
Mm-hmm.
Now, there are some folks out there that love DIY, that do it themselves. They want to climb a ladder and put up cameras and do the wiring and everything. Generally, we find that not to be the case for our subscribers. DIY has existed for many, many years, over 10 years, and we've continued to grow during that period. I will say that DIY has probably increased the awareness of security systems, because obviously, you see the ads, right?
Of course.
A lot of ads on TV and stuff.
Sure.
I think from that point of view, I think it's possibly been helpful because it's created the awareness of the smart home. For like, in some cases, maybe rental houses or apartment houses, you might have a DIY system. You might not have an Alarm.com system, although we do have a multifamily solution as well. That's a small part of our business. I would say the DIY generally is not what we consider a competitive threat, correctly.
No, it's a great, it's a great point. Yeah, and while I have you here, Steve, as the CFO, I wanted to talk about, you know, how we should think about margin profile going forward...
Yeah
the next several years, you know, potential to expand margin. You already talked about 80%+ on the software side and obviously lower on the hardware. Margin profile, you know, potential to increase free cash flow.
Yeah.
How we should think about that. Finally, we all care about too, is just returns to shareholders and how we as shareholders should think about...
Right
returns to us.
Yes, the margin profile, SaaS is 85%-86% margin. Gross margin, very predictable, very consistent. Hardware has kind of moved around. A year ago, hardware was impacted by the supply chain dynamics. We had to air freight in a lot of hardware cameras, so our margin got to for hardware, got to 11%.
Yeah.
This last quarter, we were up to about 23.5% gross margin for hardware. We're probably going to be in that mid 25% range for hardware going forward. That's obviously very helpful. The overall margin, in the past, we've been able to have an EBITDA margin of 20%+ and in fact, before we were public, we were in the 30%+ range. This last five years, I would say we've been investing quite a bit, especially in R&D.
Mm-hmm
-given all these growth drivers. You know, we've gone from 22% of revenue in R&D to 29%. That's not sustainable forever, right? At some point, R&D has to come down to a more normalized range, like I would say 12%-14%. At some point in the future, as R&D, you know, investment comes to a normalized range, we should be able to see that impact on the EBITDA margin to get back up to the higher levels. The question is exactly when that would occur is hard to say. There is a lot of leverage in the model.
I mean, we could be in the +30% margin range today for EBITDA, but it would be at the cost of the investments in these, you know, in commercial and international and AI, in demand response for EnergyHub. All these areas we're investing in, we think are, you know, paying off. We're seeing good growth from those areas. Those areas are growing over 25% year-over-year. You're right, at some point, the EBITDA margin will go back to, you know, where it was before we went public.
Okay, then the use of cash, right?
Yeah.
I'm assuming healthy top-line growth, margin expansion.
Yeah
cash flow generation.
Yeah.
How do you think about use of cash?
Yeah. use of cash, we have done acquisitions. Generally, those have been smaller acquisitions. we did EBS, which cost us about $10 million of cash in Q1.
Mm-hmm.
We did Vintra. I think Vintra was about $7 million of cash. I think that was in Q4. Generally, those have been smaller acquisitions. Last year, we did do a stock buyback, where we used about $80 million of our cash to buy back our stock, about 2.7% of our stock. Beginning of this year, the board did authorize another $100 million of stock buyback over the next two years, and so, those were some of the uses of the cash. We do generate cash. The company is.
Mm-hmm
-quite cash flow positive. one of the challenges, of course, you may have heard about, is this new tax law, the Section 174, which penalizes companies that have R&D investment.
Yes
requires basically to capitalize R&D, it accelerates your tax. That actually has hurt our cash a bit. That's costing us, you know, $40 million-$50 million of our cash this year because of the need to pay that tax. At some point, it neutralizes and evens out. There is some talk of that being repealed. If you look at our operating cash flow and our free cash flow, ex this tax effect, it's been. Operating cash flow has been around $80 million-$100 million on a normalized year.
Mm-hmm.
Last year was also impacted by the supply chain, where we bought a lot of inventory ahead of time. In normal times, we should be able to generate, let's say, $60 million-$80 million of free cash flow per year. We don't spend a lot of money on capital equipment.
Okay.
Generally, it's for servers, and it's for office fit out, so usually our CapEx is about $10 million per year on a normalized basis.
That's a great overview. We have about a minute left. Not a lot of time, but I want to give you a chance to talk about the AI roadmap.
Yes.
We already discussed a couple of the products that you have today, but maybe talk about the roadmap going forward and how AI can be ARPU accretive.
Yes, AI is a huge opportunity for us, like, we doubled down with Vintra, the company we just acquired. There's a number of capabilities and feature sets that we're working on. For residential, there's a number of use cases, detecting people, you know, when somebody goes in a swimming pool.
Mm-hmm.
For commercial, continuing to identify and quickly being able to identify unusual patterns and being able to track when there is an unusual pattern. We also have a business we acquired called Shooter Detection Systems, which has kind of been stealth, but we think there's a lot of opportunity there, combining it with a commercial offering, combining it with, you know, being able to do predictive analytics when there's unusual activity. The shooter detection will detect gunshots, combining that with Noonlight, where it provides notification to first responders. So we're putting all this together. We think it'll be a compelling solution for schools, for government-
Mm-hmm
-for, companies, for campuses, for malls, and so using all that technology. We're definitely doubling down on AI.
That's a great point. Steve, thank you again so much.
Thank you.
for being here.
Thanks, Mike.
Yeah, you take care.
Great to be here. Thank you very much.
Okay. Thank you, all.