Alarm.com Holdings, Inc.
Q2 2019 Earnings Call Transcript

Published: 9 Aug 2019

[Operator:]

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Alarm.com's Second Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. . Now, it's my pleasure to turn the call to David Trone, Vice President, Investor Relations.

[David Trone:]

Thank you. Good afternoon everyone and welcome to Alarm.com's Second Quarter 2019 Earnings Conference Call. As a reminder, this call is being recorded. Joining us today from Alarm.com are Steve Trundle, President and CEO, and Steve Valenzuela, CFO.

[Stephen Trundle:]

Thanks, David, and welcome to everyone joining our call today. We are pleased to report another solid quarter that exceeded our expectations. SaaS and license revenue in the second quarter grew to $82.3 million, up 16% year-over-year. Our non-GAAP adjusted EBITDA in the second quarter was $27.7 million. During the quarter, our service providers continued to have success in the market. They added new subscribers and increasingly deployed our more advanced services. One particular area of strength for our service providers, continues to be with our video services. For the first six months of the year, the number of subscribers electing a video service plan is up about 40% from the first half of 2018. Adoption of our video analytics service, which we initially released at the end of last year, continues to grow as well. The improved user experience and quality of service enabled by video analytics is driving increased overall demand for video. Overall, I am pleased with our progress in the video category. As I have stated previously, we have been steadily increasing our focus in this area. We have both ramped up our internal R&D investments and made select acquisitions to strengthen our tech stack and provide a solid product to service providers. The market is highly competitive, but we are competing well. In order to continue to innovate in the video category and in other growth categories like commercial and access control, we have worked hard to further build out our R&D team. We ended the second quarter with an R&D team of 554 employees, not including contractors. As the rest of the year unfolds, we expect to continue to invest in strengthening our capacity to drive best-in-class products and innovation into the markets we serve. During the second quarter, we also expanded the ecosystem of supported third-party hardware products that work with the Alarm.com platform. A particular focus was on the IoT devices that our builder channel partners desire. We added devices Eaton and Leviton which are brands that we see builders frequently installing for lighting control. These additions fit nicely with existing integrations for audio, video, lock control, shape control and smart thermostats. With the array of best-in-class devices available in our ecosystem, builders can tailor solutions for the target buyers and the design aesthetics of a given community. This quarter, we also significantly expanded our lineup of supported security control panels to give our service providers additional options to install in their customers properties. Importantly, we advanced the capabilities available to our service providers, by working with our existing control panel partners on new models that they are bringing to market. With expanded touch screen interfaces and our LTE dual-path gateways, we can now offer new capabilities to subscribers such as display and video feeds on the control panel.

[Steve Valenzuela:]

Thanks, Steve. I will begin with a review of our second quarter 2019 financial results and then provide guidance for the third quarter and our raised outlook for the full year 2019 before opening the call for questions. SaaS and license revenue in the second quarter grew 16% from the same quarter last year to $82.3 million. This includes Connect software license revenue of approximately $11 million for the second quarter compared to $10.2 million for Q2 2018. Our SaaS and license revenue renewal rate was 94% in the second quarter, at the high end of our historical range of 92% to 94%. Hardware and other revenue in the second quarter of $39.3 million, up 17.3% over Q2 2018. The increase in hardware revenue was primarily due to an increase in sales of our video cameras. As Steve mentioned, we continue to see increasing adoption of video by both new and existing subscribers. Total revenue for the second quarter was $121.7 million, up 16.4% over the same quarter last year. SaaS and license gross margin for the second quarter was 84.6%, consistent with prior quarters. Hardware gross margin was 18.9% for the second quarter compared to 24% for the same quarter last year primarily due to product mix. Total gross margin was 63.4% for the second quarter compared to 65.1% for the same quarter last year, mainly due to lower hardware margins.

[Operator:]

. Our first question is from Nikolay Beliov with Bank of America.

[Jacqueline Cheong:]

Hi, this is actually Jacqueline Cheong on for Nikolay. Quick question on when do you think international and commercial revenues will inflect and what is the adoption curve of customers in regards to those 2 segments?

[Stephen Trundle:]

Sure. Hi, Ashley. I don't know that you'll see sort of an overnight type of inflection move in the chart. We're seeing steady sort of quarter-over-quarter increases in the number, both the absolute number of customers we're putting on in both of those segments and that's sort of with a nice growth rate. But I don't think you're going to see sort of a big bang moment, partially a reason for that is we're building basically a long-term path to market by educating service providers in those various segments, making sure they're trained. You've got a fair amount of set-up required which of course creates its own nice barrier to entry. But we think we're making good progress long term. We can see, if we think about international, we've always said we think international can and eventually will be as much as a third of the business and we're sort of tracking early days at the moment, but tracking towards that goal.

[Jacqueline Cheong:]

And any comment on the adoption curve of customers?

[Stephen Trundle:]

Customers -- do you mean our commercial customers. The adoption curve of customers. I'm not sure I understand what you meant, Ashely.

[Jacqueline Cheong:]

Like, how do they typically roll out with Alarm.com? How does that trend over time?

[Stephen Trundle:]

Okay. So if we go -- really, when we think about customers, there are 2 levels. There is the service provider and that adoption cycle is typically a year of evaluation of testing of maybe some piloting, some in-house work towards the end of that period. I think we, of course, are working to complete contracts and we are beginning the training. They're preparing their go-to-market pricing. So, you're basically looking with typical meaningful service provider, whether it'd be domestic going into the commercial segment or international, a year, maybe a little more in some cases of preparation and everyone getting comfort. You have to remember that what we offer is sort of core to their business and core to how they present themselves. So, it can be a meaningful transition. Once we get that work done most partners will de-risk the process by sort of gradually turning the lights on and that process itself may take another year to year and a half as they literally go from one geography to the next, to the next, and begin the deployment. When you get into sort of non-US markets, you do see some additional obstacles, which would be, regulatory environments by country may vary. So, you may have a service provider that's doing business in 2 different countries that are adjacent to each other. One has different set of regulatory requirements and the other one may take a little longer, but generally, we think about sort of a -- from day 1 to sort of fully deployed ramp being 2 year, 2.5 year type of ramp at the service provider level. Then, obviously at the customer level, it gets turned on, it works and they're happy on day two. So once you create the end customer, that adoption is very quick.

[Operator:]

Thank you. And our next question comes from Adam Tindle with Raymond James.

[Adam Tindle:]

Steve Trundle, I just wanted to start, first, by acknowledging obviously SaaS and license revenue growth quite healthy versus expectations. And I don't think the macro environment is great based on the results in the channel around you, but there obviously has been some investor consternation around a couple of quarters of moderation in SaaS growth on a year-over-year basis and your forward guidance indicates that's going to continue. So, just hoping you could maybe take a second to parse through some of the drivers of that moderation between churn, ARPU trends, gross adds, maybe just go through each, how it's impacted so far this year, and some of the potential drivers to those as the year progresses with the initiatives that you have.

[Stephen Trundle:]

Sure. Yeah, Adam. So as you said so far, we're only 6 months into the year, but so far the year has progressed at a -- I'd say, at a better rate than probably we expected at the beginning of the year. I think we began the year forecasting sort of a 13% growth rate on the SaaS line anyway and with the increase on guide that we have out now, we've moved that up to 14.5%. So the year is -- things are probably better than we expected. I think if we go sort of to the internal market drivers, it's such a diverse market and you can have parts that are doing very well while you have other parts that are a little soft. I think as you look at us, you have, I think, Steve just commented. As example, rev retention is actually going pretty well. We're at the high end of our range at 94% but you have to keep in mind that each year, the base that you're attempting to retain is also getting bigger. So the impact of even that 6% is more meaningful and that's of course, revenue attrition that we have to replace each year. So you have that as a driver. If we look, sort of, at the market right now, I think, we've seen slightly tighter credit market than what we're historically used to, especially in North America and that can be somewhat constraining for our service providers and this really gets to sort of what -- how much will a lender loan against subscriber acquisition cost, the number's a little lower now than it was probably 2 years ago. I think everyone sort of sorting out exactly what the new entrants are doing, whether they are having an impact on the market. Our take is, really not. I mean we've always said that the DIY and sort of the point product segment has existed. It hasn't really had an impact on our core addressable market of those people who want to have professional monitor security. That continues to be the case, but folks are trying to sort that. So, you've got a bunch of, kind of, inside the market drivers and then you have, in our case, certain amount of latency as we configure and operationalize various segments associated with our growth initiatives. So, it's hard to predict exactly when. I think, the question a moment ago was, when's the inflection point. It's hard to sort of predict exactly when that inflection point will be. And there's really not ever an absolute inflection. It just takes some time to build into those initiatives. So those are some of the things we're seeing, but like I said so far, on a year-to-date basis, we're pleased with the market being -- probably, the market being a bit healthier than we would have thought at the beginning of the year.

[Adam Tindle:]

Okay. That's really helpful. And maybe just a follow up, obviously acknowledging revenue performance has been very strong and raised. The adjusted EBITDA guidance is actually, I think, been kept at this level for a couple of quarters after some solid performance on that number and I think the benefit from the impairment charge reversal this quarter. I imagine maybe there is some exogenous factors in there. I don't know if maybe tariffs are impacting or indication for appetite for increased spending. So, maybe just some of the buckets that lead you to keep the adjusted EBITDA guidance at the same level.

[Stephen Trundle:]

I think, it's kind of a couple of things. So first, on the opportunity side, we an internal struggle for us is we're excited enough about the different opportunities that we see, especially when we think about where we want the business to be in 5 to 10 years. That we really sometimes struggle to prioritize and make decisions on which domain is best to invest in. Do you invest in creating commercial for international or do you invest in additional capabilities for video for your average domestic customers. Sort of that constant tug of war that we face. And we think, actually, all of those or nearly all of those things that were staring at represent good places to deploy capital. So, we already have sort of a natural internal tension that makes me a little bit reticent to want to put ourselves in a place where we're more constrained in the amount of investment that we can actually make to go after long-term opportunity. So, I have a natural sort of desire to preserve our capacity, if you will, to build the company over the long haul. So you got that tension. This year's been a little bit special, and probably in terms of how we've moved relative to what we initially guided. This has been a year where we've needed to keep an eye on Twitter literally and we have had some uncertainty emerge around tariffs and what those cost will be to the business. The mere sort of presence of that dynamic has at times created some disruption in the supply chain. So, we've been reticent, I think, to get comfortable that all of those issues just sort of go away in the next month. And I think, we're pleased that we've been able to stick by our prior guide but we're kind of reluctant to jump out in front of it while there is so much still going on in that domain.

[Operator:]

Our next question is from Kevin McVeigh with Credit Suisse.

[Kevin McVeigh:]

Hey, Steve, I wonder if you could just flush out the approach on tariffs? Can you just remind us kind of where you are in the process today and then to the extent we get this next round, how should we think about kind of sourcing and other areas versus maybe an ability to pass that on to customers?

[Stephen Trundle:]

Right. So the way we think about it, yeah, we've had some exposure already on a year-to-date basis with products like the Alarm.com Smart Thermostat with some of our cameras. About a third of our overall hardware product is actually produced in China. A larger component of the, I mean, when you get down the component level, so even things that we produce in our Utica, New York facility or that we produce in Mexico, one of the componentry is coming from China specifically Baoding and recently we've seen List -- we know List 4 is in development. There is an emerging set of tariff costs there. So I think we're all sort of trying to figure it out, but the way we think about it, first, we are seeing indications from our suppliers that in most cases there, they're making real efforts to move effective parts of their operations to other countries that where the tariffs wouldn't apply. So we're seeing some of that transition. We are looking occasionally shifting things around. So I think, if everyone had a year and knew this was coming, then you'd probably see a lot of preparation for it and supply chains would have been sort of ready. I think the fact, you just can't move something, especially proprietary product, you can't move it overnight from one place to the other. So that's the dynamic we see. In terms of the way the that costs flow through in our -- I think each company treats it differently. You try to get it out of your suppliers. So, if you can't get it there, at some point, either the company, meaning we or the end customer, or someone in the middle has to absorb the tariff cost and it's sort of on a case-by-case basis by product. But generally I think our service providers understand that this is not -- you look at the gross margins, we run on hardware and you look at which are intentionally low and you look at this additional cost and most are understanding that there is a new tariff cost and as long as we call that out, we can pass through the bulk of it.

[Steve Valenzuela:]

Kevin, one thing we've done as well is we have set up a warehouse in Taiwan for international customers. So, we don't have to ship it through the U.S., bear the tariffs. So, we'll go directly from Taiwan to Europe and Asia.

[Kevin McVeigh:]

That's super helpful. And then just, if I heard right, did you say the commercial opportunity could be about a third of revenue. If so, is that primarily just based on the STANLEY deal you signed already or would that assume some penetration in the U.S. as well. And what type of time frame you think, would it take to kind of get to that level of contribution?

[Stephen Trundle:]

Yeah, Kevin, it's Steve Trundle. I hope I said on, when I threw out the third number, I meant to say that we saw long-term international being about a third of our of revenue. So I think that's not a new kind of guidepost for us. We've always felt that would be the case. I don't think we've really put out an estimate on percentage of revenue long term that will be commercial. What we have said is, it's kind of early days. It's a growing category. It's growing nicely right now, but I don't think we're at the point of -- to project long-term percentage of revenue there.

[Operator:]

Our next question comes from Reed Motulsky with Imperial Capital.

[Reed Motulsky:]

As the provider of the back end of the Command and Control system what will be Alarm.com's responsibilities and possibly fees regarding providing education and back up customer service for those installing the new system.

[Stephen Trundle:]

Hi. So, what are our responsibilities to -- you said to educate those installing the new Command and Control system?

[Reed Motulsky:]

Yes.

[Stephen Trundle:]

Basically in that case, Command and Control is ADT's new system and ADT is really owning the deployment of that technology and they're doing a great job with it and they take ownership of training the installers and the technicians and have been training installers and technicians for years. So it's right in their wheelhouse. Our role is really to support them the best we can making sure we're getting them any information they might need from us, but we're not front and center in that educational process.

[Reed Motulsky:]

Nice and what types of pipeline discussions Alarm.com having regarding its EnergyHub subsidiary and what are the types of clients and the types of services that the company is discussing?

[Stephen Trundle:]

So with EnergyHub, it's really more of the same and I think we've indicated in prior quarters that's a place where we have some momentum. We're pleased with the management team and the entire team there and what we're trying to build out are essentially the benefits of scale. We add on each quarter. We tend to add on meaningful additional utilities who want to reduce carbon emissions and who want to be able to level load their production. And at the same time, we go back and we work with the IoT companies and including almost anyone that wants to work with EnergyHub to make sure that we're able to connect to and gather information from each of those devices. So, those are the basic two marching orders for that business. They're doing a good job on both of those vectors and as they continue to make progress, I would say, they become relevant to more utilities and likewise relevant to more IoT device makers and that's sort of what we have going on. So we didn't talk about them specifically, but it's been continuing to see good progress there, and those are the 2 things they're really focused on.

[Reed Motulsky:]

Got it. And can you -- I know you guys touched on Europe a bit earlier, but can you guys also talk about Australia and Asia, if there's any progress being made there or if it's slowed down the priorities list here?

[Stephen Trundle:]

Sure. So Australia continues to, I don't think I have a meaningful update this quarter. As far as I can remember, it's been sort of continued progress. We did set up an office there in Sydney. So we're beginning, I think, high level. You're seeing us begin to get comfortable with the long-term opportunities and markets when we make the decision to put physical offices in the ground and a location. We did that in the prior quarter in Australia. Southeast Asia's still very early, more of a pipeline stage there where we are talking to service providers in each of the geographical markets, but don't have any. I wouldn't say we don't have traction, we're happy with the pipeline, and the testing and what not, but we're not driving a lot of revenue out of Southeast Asia yet.

[Operator:]

Our next question comes from John DiFucci with Jefferies.

[Parthiv Varadarajan:]

This is Parthiv on for John. You guys talked briefly about the 3G upgrade opportunity in your prepared remarks. I just wanted to get a sense. Is there any quantitative or qualitative color you could maybe give us to help us size that opportunity over the next couple of years and that would be both, I guess, within your current installed base and the broader market that might be up for grabs.

[Stephen Trundle:]

Yes, I mean, so qualitatively, there are meaningful set of subscribers that are already Alarm.com subscribers and our service with 3G connections. If we took the percentage of our overall subscriber base where we are contracted to actually provide the cellular communication capability and we're actively providing that, it's roughly a third, around 30% or so of our subscribers and our intent is to upgrade them as much as we can. Again, with our partners through normal course. So we've run some different types of campaigns. I think in most cases, we see it as an opportunity to go back to the customer upgrade, the functionality to more modern functionality, probably add cameras. And then, we have to also work hard with our service providers. For some of them, it's a meaningful issue that we're managing through. It creates even for our service provider both opportunity and then also at some point. Let's say, we're talking about 2022 time frame, but at some point that gets closer than it is today, and we won't have to accelerate the pace, but we've seen them move out pretty well this year. We ran a nice campaign at the beginning of the year and it got a lot of people moving and we're happy with how that's going.

[Operator:]

Our next question comes from Michael Latimore with Northland Capital.

[Michael Latimore:]

This is Pawan on for Mike. I have two questions. How many service providers are selling commercial now and what percent are sold like at least something?

[Steve Valenzuela:]

So the question was what percent of service providers are selling commercial?

[Michael Latimore:]

Yes, yes, exactly.

[Steve Valenzuela:]

Boy, I don't have that data point unfortunately right in front of me to give you and we may not actually have it readily available here. So can't really answer that question. What I can maybe give you as an indicative -- an indication is about 4% of our new subscribers are coming on to a commercial service plan. I think that's pretty widely distributed across service providers. And with that rate, obviously, the commercial customer is using a lot of capabilities that may not be applicable to a residential subscriber. So that commercial customer is generating or that base of customers -- that 4% are generating about 8% of the new subscription revenue.

[Stephen Trundle:]

So, we're training service providers all the time. So that number keeps on changing and keeps on growing. Clearly, that's a focus for us in terms of providing them the training.

[Michael Latimore:]

Okay. And how many people in the R&D department are working on video analytics.

[Stephen Trundle:]

Good question, yeah. I think if you took video as an overall category, you've got cameras in there. You got end user functionality, how that video is rendered inside the app, different types of interfaces for scrubbing through video. I'm going to sort of leave all of that out and just say that the video analytics team is -- and actually, I have said, I don't want to reveal exactly that how many we have working, but I'll give you an idea that it's dozens, but not hundreds that are actually video scientists who are working every day on improving that offering and that's probably what I would say there.

[Steve Valenzuela:]

Yeah, in January of 2017 we required video objects which brought on the initial team and we've grown that team quite a bit since then, that's really the beginning stages, with all their knowledge, 18 years or 17 years of knowledge they brought working with many different government programs we've enhanced that team quite a bit over the last couple of years.

[Operator:]

And our next question comes from Darren Aftahi with ROTH Capital Partners.

[Darren Aftahi:]

Just two, if I may, First, could you disclose what other SaaS revenue was in the second quarter and then Steve Trundle, your commentary about 40% video growth over the first half. I'm just kind of curious if you'd kind of break that down between kind of your core video service and then perhaps add-ons like video analytics, what's making up that component?

[Steve Valenzuela:]

Yeah, and I'll start with the first question. Other SaaS -- other segment was $4.2 million in Q2. That was up about 46% year-over-year. It was down sequentially from Q1 which was around $4.6 million.

[Stephen Trundle:]

And then the second question was, where is the video growth coming from. And I guess, I'd just say, generally at this point, If we look back a year, about a fourth of all the installations were coming on with the video subscription. Today, that number is above a third. So we're just seeing steadily more and more of our subscriber base even at time of install opt for video and then a meaningful number of existing customers that may not have the capability or requesting it. The breakdown is, I do think I made the point in my prepared remarks that, analytics, If I were to look at those customers who have an outdoor -- one of our newer outdoor video cameras, at this point -- and we feel like that capability has only been out a bit, but 60% of them are taking analytics, simply because the capability is so nice and so much better than what's existed in the past. So, I think the availability of that technology is driving kind of a -- more or less a wholesale move, all video products are moving. The doorbell video product continues to be sort of the hot product as are the outdoor video cameras that support video analytics.

[Operator:]

And our last question is from Jack Aarde with Maxim Group.

[Jack Aarde:]

Hey guys, good quarter. Just had few questions on -- did I hear correctly the subsidiary business, other revenue, was $4.2 million in Q2?

[Steve Valenzuela:]

For SaaS, that's right.

[Jack Aarde:]

For SaaS, okay. Got you. And then, if I look at hardware and other GM -- gross margin, while it was down year-over-year, it did improve by about 140 basis points or so from last quarter, despite the tariffs and all these other cost factors. So what specifically is improving that hardware gross margin, I guess, specifically in this quarter relative to the prior quarter?

[Steve Valenzuela:]

Yes, that was up about 150 basis points quarter-over-quarter and we do run different promotions, different times because we really use hardware as an enabler for SaaS. So, we're driving really the adoption of sales with constantly lowering the price where we can of hardware products including cameras and then you've got a different mix of cameras, you have different margins and different price points. But it was really relatively -- quarter-over-quarter relatively minor change in terms of about 150 basis points.

[Stephen Trundle:]

Yeah, I don't think we know exactly why that would move that little amount, but it was kind of just noise in the system really.

[Steve Valenzuela:]

Yeah. We've said in the past that you should think really about hardware margins in the 18% to 20% range and we typically kind of been in that range over the last couple of quarters.

[Jack Aarde:]

Got it, that's helpful. And if I can just ask quickly, is there any update you can share on PointCentral specifically or maybe how the partnership with Invitation Homes is developing? Any developments there you can share?

[Steve Valenzuela:]

I -- continues to perform well. I mean, PointCentral continues to perform well. We think there is a tremendous opportunity in the multi-developments space and the rental property space. They continue to perform very well. If you look at it, they're part of the other segment and the other segment SaaS revenue was up 46% year-over-year in Q2. So they're part of that contribution.

[Stephen Trundle:]

Maybe a more general update there. So my impression, just watching activities, Invitation's going fine. There continues to be the same installation rate and everything. So nothing really on the negative side has changed. The business has evolved some. We're beginning to include some of -- on a selective basis, some of our service providers and the fulfillment side of that business and growing into in the multifamily segment. So, we're excited about it. I don't think we have a super discrete update there this quarter, but generally, things are fine.

[Jack Aarde:]

Okay, that's helpful. Thanks guys. Great quarter.

[Operator:]

Thank you. And ladies and gentlemen, this concludes our Q&A and program for today. We thank you for your participation. You may now disconnect. Good day.