Alarm.com - Q3 2023

Transcript

Operator (participant)

Good day, and thank you for standing by. Welcome to the Alarm.com Q3 2023 Earnings Conference Call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there'll be a question-and-answer session. To ask a question during the session, you'll need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised today's conference is being recorded. I would now like to hand the conference over to your speaker today, Matt Zartman, Vice President of Investor Relations. Please go ahead.

Matt Zartman (VP of Strategic Communications and Investor Relations)

Thanks, Kevin. Good afternoon, everyone, and welcome to Alarm.com's Third Quarter 2023 Earnings Conference Call. Please know that this call is being recorded. Joining us today from Alarm.com are Steve Trundle, our CEO, Dan Kerzner, our President of our Platforms Business, and Steve Valenzuela, our CFO. During today's call, we will be making forward-looking statements, which are predictions, projections, estimates, and/or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. We refer you to the risk factors discussed in our quarterly report on Form 10-Q and our Form 8-K, which will be filed shortly after this call with the SEC, along with the associated press release. The call is subject to these risk factors, and we encourage you to review them.

Alarm.com assumes no obligation to update forward-looking statements or information, which speaks as of their respective dates. In addition, several non-GAAP financial measures will be discussed on the call. A reconciliation of the GAAP to the non-GAAP measures can be found in today's press release on our investor relations website. I'll now turn the call over to Steve Trundle. Steve?

Steve Trundle (President & CEO)

Thank you, Matt. Good afternoon, and welcome to everyone. We're pleased to report another quarter of solid results. Our SaaS and license revenue in the third quarter was $145 million, up 8.9% over the same period last year. Our Adjusted EBITDA in the third quarter was $41.4 million. I wanna thank our service provider partners and the Alarm.com team for their continued strong performance. During the quarter, we meaningfully outperformed our SaaS target, despite some softness in difficult-to-predict hardware revenue. The diversity of our business is worth highlighting as our growth initiatives continue to make substantial contributions to our SaaS results. As many of you know, we typically conclude our third quarter call by providing a very early look at how we think the business will perform in the following fiscal year.

I'm gonna keep my comments brief today, but provide some context to the 2024 numbers that Steve Valenzuela will outline. I'm also excited to welcome Dan Kerzner, the President of our Platforms Business, to the call to update you on a few product development initiatives. Before I hand things to Dan, I want to comment further on where we are strategically and what we see in the year ahead. Overall, I'm pleased with our growth in SaaS revenue this year and our opportunity to maintain that momentum through next year. In 2023, we successfully accomplished some belt-tightening in the business and have been able to produce the same Adjusted EBITDA on a real dollar basis as in 2022. We achieved this despite an unexpected setback late last year that impacted our IP license revenues and which generated material legal costs.

Even as we made these adjustments, we continued to build strong businesses in commercial intrusion and access, residential and commercial video, and energy management. We've built an international business that now serves over 60 countries globally and includes partnerships with some of the largest security companies in the world. We have also established toehold positions in the HVAC channel, the multifamily housing segment, the active shooter detection vertical, and the IoT device monitoring space. We expect these growth initiatives to continue to generate increasing contributions to our overall performance next year and become more efficient with scale. In 2024, we will continue to pursue our core strategy. We will invest back into the residential and commercial solutions that our service providers sell and deliver to the market every day, while also continuing to build and invest in our growth initiatives.

We continue to see good results from the investments we have made in video, commercial, international, and energy management, and expect these areas will steadily be drivers of our overall growth in the future. In summary, I'm pleased with our third quarter results and the execution of our plan, and I want to thank our investors for their continued trust in our business. With that, let me turn things over to Dan Kerzner to provide an update on our video business. Dan?

Dan Kerzner (President of Platforms Business)

Thanks, Steve. I'm pleased to join our call today and speak with our investors and analysts. The Platforms business includes all product development for our core commercial and residential platforms, as well as sales and marketing for our largest market, North America. We drive profitable revenue growth across global markets through new product releases that expand our market opportunity, increase ARPU, and build on our service provider partners' strong competitive position. While the team is focused on a range of technology domains, I'll use today's call to update you on several new enhancements to our user experience and video platform. Updates to our user experience have been motivated by the fact that the typical connected property solution on the Alarm.com platform has become increasingly sophisticated with more and different devices. This increase, particularly focused on video, has influenced how subscribers use and interface with their system.

We continually refine and optimize our user experience to provide frictionless and intuitive access to the information and commands that subscribers value most. During the quarter, we launched an enhanced version of our mobile app. The modernized navigation provides one-tap access to high-use features. Design also integrates a curated graphical activity feed that incorporates video clips directly into a comprehensive timeline of activity at the property. We also developed an enhanced interactive scrubbing interface for our continuous video recording solutions. This is a crossover feature that both increases usability for residential customers and fits the commercial market. The use cases for commercial subscribers include quickly checking to see which employees opened or closed the store on time, or tracking unexpected entries or exits to an office. The enhancements and new capabilities designed into the mobile app were informed by our extensive subscriber usage data.

In a single month, earlier this year, nearly 100 million live video streams were initiated in our app and over 50 million swipes between video feeds. This data supports the new user experience design, which expands the touch points for video content within the app experience. Now, I'll shift to several new products that highlight the continued evolution of our video platform. The upcoming release of our new 729 floodlight video camera product line leverages our intelligent, video-based, proactive deterrence capabilities into a new camera form factor that we believe will gain traction. The new 729 video camera includes a four-megapixel sensor, wide area lighting, responsive multicolor LED lights and sirens, and two-way voice, which allows the central station operator to mic down through the camera to an outdoor location.

It also operates our enhanced video analytics software called Perimeter Guard, which seamlessly connects to our alarm response software. The 729 will be used by our service providers to detect potential bad actors and engage them with a series of escalated responses designed to proactively deter malicious activity. We've grown our video business to a significant scale. Our AI-powered video analytics software has identified about 22 billion events for subscribers through the detection of either people, vehicles, or animals over just the last 12 months. We recently added package detection to our video analytics offering. Since it began rolling out in September, we have alerted subscribers about package deliveries over 700,000 times. To summarize, our research and development program is enabling us to address opportunities in both commercial and residential markets, so we can continue to deliver SaaS growth.

We're leveraging the unique strengths of our channel to deliver a differentiated and difficult-to-replicate set of capabilities that align with the long-term growth drivers of our service provider partners. With that, I'll turn things over to Steve Valenzuela to review our financial results. Steve?

Steve Valenzuela (CFO)

Thanks, Dan. I'll begin with a review of our third quarter 2023 financial results, and then provide our guidance for Q4 and full year 2023, and conclude with our initial thoughts on 2024 before opening the call for questions. Third quarter SaaS and license revenue of $145 million, grew 8.9% from the same quarter last year. Excluding Vivint license revenue, third quarter 2023 non-GAAP adjusted SaaS and license revenue grew 13.9% year-over-year on a comparable basis. SaaS and license revenue includes Connect software license revenue of approximately $5.7 million for the third quarter, down, as expected, from $6.5 million in the year-ago quarter. Our SaaS and license revenue visibility remains high, with a revenue renewal rate of 93% in the third quarter, consistent with our historical trends.

Hardware and other revenue in the third quarter was $76.8 million, down 7.5% from Q3 2022, as the year-ago quarter benefited from heavy LTE cellular module sales in advance of the 3G cellular sunset that occurred at the end of last year, and some slowing of hardware sales in the commercial enterprise market. Total revenue of $221.9 million for the third quarter grew 2.6% year-over-year. SaaS and license gross margin for the third quarter was 84.9%, up slightly quarter-over-quarter from 84.6%. Hardware gross margin was 22.6% for the third quarter, up from 19.1% in Q3 2022, mainly due to favorable product mix and improved supply chain dynamics.

Total gross margin was 63.3% for the third quarter, up from 60.4% in the year-ago quarter, mainly due to the improvement in hardware margins. Turning to operating expenses. R&D expenses in the third quarter were $61 million, compared to $55.6 million in Q3 2022, mainly due to an increase in headcount and related compensation expenses. We ended the third quarter with 1,116 employees in R&D, up from 981 employees in Q3 2022. Total headcount increased to 1,986 employees for the third quarter, which includes employees from companies we acquired during 2023, compared to 1,699 employees in the year-ago quarter.

Sales and marketing expenses in the third quarter were $23.9 million, or 10.8% of total revenue, compared to $23.1 million, or 10.7% of revenue in the same quarter last year, mainly due to increased headcount. Our G&A expenses in the third quarter were $31.5 million, up from $28 million in the year ago quarter, mainly due to higher legal fees. G&A expense in the third quarter includes non-ordinary course litigation expense of $5.9 million, compared to $3.1 million in the year ago quarter. Non-ordinary course litigation expenses are part of our adjusted measures and are excluded from our measurement of our non-GAAP financial performance. In the third quarter, GAAP net income was $19.5 million, compared to GAAP net income of $18.3 million in the year ago quarter.

Non-GAAP adjusted EBITDA in the third quarter was $41.4 million, up slightly from $40.8 million in Q3 2022. Non-GAAP adjusted net income increased to $30.6 million, or $0.56 per diluted share in the third quarter, compared to $30.1 million, or $0.55 per share for the third quarter of 2022. Turning to our balance sheet, we ended the third quarter with $680 million of cash and cash equivalents, up $57.8 million from our cash balance at December 31st, 2022. Operating cash flow for Q3 was $62.8 million, compared to $10.2 million in the year ago quarter, and free cash flow was $60.9 million, up from $8.4 million in Q3 2022.

The increase in cash flow was from strong operating results and improvement in working capital, with collections driving down accounts receivable days sales outstanding to 45 days and a slight decrease in inventory. During the quarter, we used $6.2 million to repurchase 105,285 shares of our common stock at an average price of $58.20. Turning to our financial outlook. For the fourth quarter of 2023, we expect SaaS and license revenue of $146 million-$146.2 million. For the full year of 2023, we are raising our expectations for SaaS and license revenue to $566.9 million-$567.1 million, up from our prior guidance of $562.3 million-$562.7 million.

We are projecting total revenue for 2023 of $878.9 million-$881.1 million, compared to our prior guidance of $872.3 million-$887.7 million, which includes estimated hardware and other revenue of $312 million-$314 million. We are raising our estimate for adjusted non-GAAP EBITDA for 2023 to $143 million-$144 million, up from our prior guidance of $128 million-$131 million.

Adjusted non-GAAP net income for 2023 is projected to be $103.5 million-$105 million, or $1.90-$1.92 per diluted share, up from our prior guidance of $92.2 million-$94.2 million or $1.69-$1.73 per diluted share. EPS is based on an estimate of 54.6 million weighted average diluted shares outstanding. We currently project our non-GAAP tax rate for 2023 to remain at 21% under current tax rules. We expect full year 2023 stock-based compensation expense of $48 million-$50 million. Finally, while we are in the initial planning stages, I will provide some early thoughts on 2024, noting that these are preliminary. We currently estimate our SaaS and license revenue for 2024 will be between $608 million-$612 million.

Total revenue for 2024 could range between $908 million and $927 million. We currently project our non-GAAP adjusted EBITDA for 2024 to be between $148 million and $150 million. We will provide our initial guidance for 2024 when we report our fourth quarter of 2023 financial results early next year. In summary, we are focused on executing on our strategic business plan and investing in our long-term strategy, while continuing to deliver profitable growth. With that, operator, please open the call for Q&A.

Operator (participant)

Thank you, ladies and gentlemen. If you have a question or a comment at this time, please press star one one on your telephone. If your question has been answered, or wish to remove yourself from the queue, please press star one one again. We will pause for a moment while we compile our Q&A roster. Our first question comes from Adam Tindle with Raymond James. Your line is open.

Adam Tindle (Managing Director and Senior Equity Analyst)

Okay, thank you. I'm just trying to do the fast math here on that guidance here, Steve. And we're curious what it implies in terms of the drivers of the SaaS line. In particular, obviously, ADT has been a little bit more public about their roadmap here. It looks like if I did the math correctly, you're gonna be guiding to about 8%, or at least the initial thought for SaaS growth for 2024 is around 8%, which is very healthy coming off of a 9% comparison, so not much deceleration, and I know you tend to be conservative on that. So maybe just some of the drivers that led you to this initial look on 2024, and in particular, what the ADT assumption is in there.

Steve Trundle (President & CEO)

Hey, Adam, this is Steve Trundle. I'll start with the ADT assumption, and then if Steve wants to pick up on anything else.

Adam Tindle (Managing Director and Senior Equity Analyst)

Yeah.

Steve Trundle (President & CEO)

But yeah, you did the math correctly, first, so that's right. And, what, you know, we're using the same, I think, data points that others have on ADT, where public communication has been that they're going to initiate some activity, by the end of this year with the transition. So what, in our model, we're doing is, we have that activity, meaning that transition, modeled in to occur mostly in the first quarter of, of next year, sort of to begin late this year and then roll through, roll through the early part of next year. Yep, and then, Adam, you're right. It's about 8% growth we're projecting. And as we always do in the initial look, you know, it's 15 months out, so we're, we're giving ourselves some room here for hopefully some beat and raise.

You know, there is a challenging macroeconomic environment out there. I mean, we've done quite well, but if you look at last year's initial look, we initially guided to about 6.3% growth, and we're coming in at about 8.6% growth for the year. So we always have some, some room that we allow ourselves there to be able to do a beat and raise during the year.

Adam Tindle (Managing Director and Senior Equity Analyst)

Great. Yep, that, that's clear and looks like a healthy initial look. I guess, maybe a question on the quarter, you had alluded to the hardware piece, and I know the story is more about the SaaS line here at Alarm.com, but wanna ask a little bit more on hardware. If you could unpack some of the drivers that led to the weakness in the quarter. And if I look at the Q4 guidance, it looks like it might be flat to slightly up sequentially, if I did the math right on there for the full year. I know Q4 is, you know, typically a little bit of a seasonally soft hardware quarter, given weather and installs and stuff like that.

So looks like maybe some temporary items in Q3 and a healthier Q4 outlook. Wonder if you could unpack the drivers and the hardware piece and assumptions. Thanks.

Steve Trundle (President & CEO)

Yeah, so that's right. Pretty much flat Q4. The drivers there were, you know, and really even looking into next year. First, starting with this year, a little bit of weakness in the commercial enterprise space. We just, it's not that we're seeing orders kind of go away. We're just seeing the cycle taking longer than we expected. So in the last quarter, we saw a little weakness there. We had a couple of little supply chain issues that were more modest. And then even on the residential side, we're seeing a couple of things going on. Fewer, you know, first, many fewer LTE modules being sold because the upgrade cycle from 3G to LTE is mostly over at this point. So that's kind of been drying up.

Then, the last on the hardware side would just be the macro conditions are creating a world which is sort of good and bad for us in a way where you're having fewer moves on the residential side. So you're not doing as many new installations necessarily, but you're also having less churn on the residential side, where you know, we expect probably revenue retention will trend up a little bit. So that's but you see slightly less hardware on that side as well.

Adam Tindle (Managing Director and Senior Equity Analyst)

Got it. Thank you.

Operator (participant)

One moment for our next question. Our next question comes from Saket Kalia with Barclays. Your line is open.

Saket Kalia (Managing Director)

Okay, great. Hey, guys. Thanks for taking my questions here. Steve Trundle, maybe for you. Can we just talk a little bit about the growth businesses that you touched on last quarter? I can't remember if it was 30% of the business growing at 25 or vice versa, but it was a really interesting stat. I don't expect it's changed much, you know, in just one quarter. But curious, if you could just expand on kind of what you're seeing in a couple of those biggest growth businesses.

Steve Trundle (President & CEO)

Yeah. First, your recollection is correct. That's, I think what we communicated last quarter was 30% of the, you know, 30% of the growth business is represented around 30% of the SaaS, and we're growing at around 25%. So that's continued. You know, the drivers there are really, EnergyHub being one, where, we did recently put out a press release about, you know, this past year being really sort of a record-setting year for us with the number of events called and the number of I think it was over 1,800 events we've called year to date, meaning demand response events on behalf of utilities, and, moved around quite a few gigawatt hours of power.

I believe more than 200% more power we moved off the grid, you know, at key moments this year versus last year. So you're just seeing a lot more usage there, which allows us to keep growing that business. And then the team's focused right now on expanding into the broader resource space to include EVs, in particular. So a lot of work going on there, and we see that as sort of another growth vector in that business. The other couple places are the international business, which continues to clip along at roughly that same growth rate.

In terms of their SaaS growth can be a little lumpy, but we still see mostly green fields internationally, where we're you know in the early days of a bunch of new relationships and trying to help partners get up to scale and to adopt you know the full platform, to sort of move from you know the basic interactive security offering to a full offering that includes video and and elements of our automation solution. And then the next would be just sort of the overall commercial play both commercial intrusion, commercial access, and I guess I should say also commercial video. Still you know fairly early there for us. Continue to make good headway there, both in our core business and with the OpenEye video segment.

As I noted in my comments, and as Steve noted, you know, in the third quarter, there was a little bit of a slowdown in the amount of hardware being sold through that channel. But overall, you know, SaaS growth rates were the same, and we expect that to you know, continue and to give us some tailwinds, next year.

Saket Kalia (Managing Director)

Got it. Got it. Maybe for my follow-up for you, Steve Valenzuela. So very helpful, always very helpful to get a preliminary look at next year here in Q3. And I know it is preliminary, but curious how you're thinking about legal costs for 2024?

Steve Valenzuela (CFO)

Yeah, it's a good point. Clearly, we have factored in some legal costs. It's important to point out, though, that a good portion of the legal spend for the major programs are now adjusted out to get to a certain stage. So we factor that out, that into our Adjusted EBITDA guide.

Saket Kalia (Managing Director)

Got it. Very helpful. Thanks, guys.

Steve Valenzuela (CFO)

Bye. Thank you.

Steve Trundle (President & CEO)

Thank you.

Operator (participant)

One moment before our next question. Our next question comes from Darren Aftahi with Roth. Your line is open.

Darren Aftahi (Managing Director and Senior Research Analyst)

Hey, guys. Thanks for taking my questions, and congrats on the quarter. If I could double tap, Steve Trundle on the commercial comments. I'm just trying to understand the relationship between, is the sort of cycle for hardware a little elongated, and that's what kind of contributed to maybe some of the weakness in the quarter, but the underlying strength for the commercial demand is still there? Am I, am I hearing that correctly?

Steve Trundle (President & CEO)

Yeah, that's Darren, that's what I was attempting to communicate. So, we and again, this wasn't a major pullback, but it was just enough that it was sort of noticeable. And we just, from what we can tell, really beginning sort of mid-August, we started seeing some slower, you know, or delayed purchasing cycles, where orders that were sort of in process might normally close in, you know, three or four weeks, seem to drag on, drag out of the quarter.

So that, that's sort of what I think we saw in the second half of the third quarter, is just some tapering of intensity at the enterprise level, primarily, meaning larger customers, large facilities, large big box retailers, quick serve restaurants, places like that, that would typically be installing, you know, at a certain rate. That's pretty predictable. That rate came down a bit in the second half of the third quarter. We assume, we don't know, but we assume, you know, like many people, that folks are kind of trying to get a read on the overall economy right now and thinking about the velocity of their CapEx expenditures and whether it's better to be in conservation mode or better be in sort of growth mode at the moment.

So that's our best guess, but we saw just a little bit of a slowdown in the third quarter in that space.

Darren Aftahi (Managing Director and Senior Research Analyst)

That's helpful. Thank you. And then maybe one for Steve Valenzuela. Your free cash number is exceptionally strong. I'm just curious with the collections and the DSOs. I mean, is that a sustainable sort of working capital sort of pass-through beyond adjusted debt income? I mean, as we think about free cash flow in the fourth quarter based on the implied guide.

Steve Valenzuela (CFO)

Yeah, Q3 certainly was an extraordinary cash flow quarter. Everything came together. We can't expect that on a, on an ongoing basis. You know, Q4 typically would be a, a weaker cash flow quarter. There is seasonality in that as well. So Q3, we had very favorable DSOs. We had, inventory come down a bit. Q4, we also have the, the potential tax payment related to the new tax rules around, around R&D capitalization, which might have to be paid if the Congress doesn't change that rule. And so, yeah, Q3 is certainly an extraordinary quarter for cash flow. But generally, if you look at the year-to-date cash flow of around $90 million, generally on a normal basis, the year to date, or the year cash flow usually is around $90-$100 million.

It's just that Q3, everything came together and generated that amount of cash flow.

Darren Aftahi (Managing Director and Senior Research Analyst)

Got it. Thank you.

Steve Valenzuela (CFO)

Thank you.

Operator (participant)

One moment for our next question. Our next question comes from Matt Bullock with Bank of America. Your line is open.

Matt Bullock (VP of Software Equity Research)

Hi, awesome. Thanks.

Yeah, I'm on for Mike Funk. Great to see the strong EBITDA performance. I'm curious if you could provide us an update with whether or not the Vivint impact to revenue, EBITDA, and I guess, legal expenses, has tracked with the initial guidance you provided, I guess it was about a year ago? Just trying to parse through whether or not some of this strong EBITDA performance is related to potentially lower legal expenses or how that's evolving. Thank you.

Steve Trundle (President & CEO)

Sure. Hey, Matt. Yeah, the EBITDA performance comes from, you know, a little bit stronger business than we expected at the beginning of the year. I would say success in executing on some belt-tightening initiatives and driving more profitability in the business. But we also did get some benefit, I think at the beginning of you kind of referenced about a year ago when that Vivint matter came up initially, we didn't really know. I think I probably said I don't know exactly how broad or how intense our legal burden will be, but I've got a budget for it at a reasonably aggressive level, so we did budget for it. We haven't burned at quite the level.

I think I telegraphed ballpark-ish $16 million on that at that time for this year, and we haven't burned at quite that level, but we've burned a healthy amount, and it's still an ongoing matter, and the year's not done. But I'd say it's been a little less intense than what I anticipated.

Matt Bullock (VP of Software Equity Research)

Super helpful. Thank you.

Steve Trundle (President & CEO)

Yep.

Operator (participant)

One moment for our next question. Our next question comes from Matthew Pfau with William Blair. Your line is open.

Matthew Pfau (Equity Research Analyst)

Hey, hey, great. Thanks. Just ask for one more clarification on the legal expenses. There was a decent sequential uptick. What drove that in the quarter?

Steve Trundle (President & CEO)

There is a lot of legal activity going on, as you can see. You'll, you'll be able to see it in the 10-Q, and so it's really hard to predict the legal expense, right? Because, depending on the timing of events and circumstances, so it's very difficult to predict. But yeah, it was up in the third quarter. I think it was $5.9 million compared to $3.1 million a year ago, and so it will fluctuate quarter to quarter, depending upon timing of certain events.

Matthew Pfau (Equity Research Analyst)

Okay, got it. And then, you know, as we think about the hardware guidance for Q4 and for 2024, does, you know, ADT rolling off to its own platform have any impact on the hardware line, or is that just on the subscription line?

Steve Trundle (President & CEO)

No, that also impacts the hardware line, and that is in our initial look, model that we provided. So, you know, we would expect to see fewer devices, cameras, doorbells, et cetera, being sold as they execute their transition. So it does have an impact on the hardware line.

Matthew Pfau (Equity Research Analyst)

Okay, great. Thank you.

Operator (participant)

Ladies and gentlemen, this concludes the Q&A portion of today's conference and also concludes the conference itself. You all may now disconnect and have a wonderful day.

Steve Valenzuela (CFO)

Thank you.

Steve Trundle (President & CEO)

Thank you.