Earnings Call Transcript - ALRM Q3 2023

Operator, Operator

Good day and thank you for standing by. Welcome to the Alarm.com Q3 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that 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.

Matthew Zartman, Vice President of Investor Relations

Thanks, Kevin. Good afternoon, everyone, and welcome to Alarm.com's third quarter 2023 earnings conference call. Please note that this call is being recorded. Joining us today from Alarm.com are Steve Trundle, our CEO; Dan Kerzner, 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 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 Form 8-K, which will be filed shortly after this call with the SEC, along with the associated press release. This call is subject to these risk factors, and we encourage you to review them. Alarm.com assumes no obligation to update any 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 and non-GAAP measures can be found in today's press release on our Investor Relations website. I will now turn the call over to Steve Trundle. Steve?

Stephen Trundle, CEO

Thank you, Matt. Good afternoon and welcome to everyone. We are pleased to report that another quarter of solid responsibility. 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 want to 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 and 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 going to 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 am 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 continue 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. And with that, let me turn things over to Dan Kerzner to provide an update on our video business. Dan?

Daniel 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 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 our subscribers' use and interface with their system. We continue to 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 visibility for residential customers and fits the commercial market. The use cases for commercial subscribers include quickly checking to see which employees opened or closed a store on time or tracking unexpected entries or exits to an office. 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, a 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 4-megapixel sensor, wide area lighting, responsive multi-color LED lights and sirens, and two-way voice, which allows the central station operator to communicate 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 that 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. Part of another 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 reacquired 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 on 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 31, 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 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 to $146.2 million. For the full year of 2023, we are raising our expectations for SaaS and license revenue to $566.9 million to $567.1 million, up from our prior guidance of $562.3 million to $562.7 million. We are projecting total revenue for 2023 of $878.9 million to $881.1 million, compared to our prior guidance of $872.3 million to $887.7 million, which includes estimated hardware and other revenue of $312 million to $340 million. We are raising our estimate for adjusted non-GAAP EBITDA for 2023 to $143 million to $144 million, up from our prior guidance of $128 million to $131 million. Adjusted non-GAAP net income for 2023 is projected to be $103.5 million to $105 million, or $1.90 to $1.92 per diluted share, up from our prior guidance of $92.2 million to $94.2 million, or $1.69 to $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 to $50 million. Finally, while we are in the initial planning stages, I will provide some early thoughts for 2024 noting that these are preliminary. We currently estimate our SaaS and licensed revenue for 2024 will be between $608 million to $612 million. Total revenue for 2024 could range between $908 million to $927 million. We currently project our non-GAAP adjusted EBITDA for 2024 to be between $148 million to $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. And with that, Operator, please open the call for Q&A.

Operator, Operator

Thank you. Our first question comes from Adam Tindle with Raymond James. Your line is open.

Adam Tindle, Analyst

Okay, thank you. I'm just trying to do the fast math here on that guidance here, Steve. Well, 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 going to be guiding to about 8%, or at least the initial thought, perhaps 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, in particular what the ADT assumption is in there?

Stephen Trundle, 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. But, yes, you did the math correctly first, so that's right. And 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 next year, sort of to begin late this year, and then roll through the early part of next year.

Steve Valenzuela, CFO

Yes. And then Adam, you're right, it's about 8% growth we're projecting. And as we always do in the initial look, it's 15 months out, so we're giving ourselves some room here for hopefully some beat-and-raise. And there is a challenging macroeconomic environment out there, I mean we've done quite well. But if you look at last year, the initial look, we initially guided to about 6.3% growth, and we're coming in at about 8.6% for the year. So, we always have some room that we allow ourselves there to be able to do a beat-and-raise during the year.

Adam Tindle, Analyst

Great, yes, that's clear. And it looks like a healthy initial look. I guess maybe a question on the quarter. You had alluded to the hardware piece. And I know that the story is more about the SaaS line here for Alarm.com. But do want to ask a little bit more on hardware, if you could unpack some of the drivers that led to 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 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 healthier Q4 outlook. Wonder if you could unpack the drivers in the hardware piece, and assumptions? Thanks.

Stephen Trundle, CEO

Yes, that's correct, Q4 is essentially flat. The reasons for this include some weakness in the commercial enterprise sector. We aren't seeing a decline in orders, but rather the sales cycle is taking longer than anticipated. In the last quarter, we noticed some softness there, along with a few minor supply chain issues. On the residential side, we're observing several trends. There have been significantly fewer LTE module sales since the upgrade cycle from 3G to LTE is mostly complete. This has been a diminishing source of revenue. Additionally, the broader economic environment is creating mixed outcomes for us. On the residential front, with fewer people moving, new installations are decreasing. However, this is offset by reduced customer turnover, which we expect will slightly improve revenue retention. Therefore, while there is slightly less hardware being sold in this segment, our overall outlook has some positive aspects.

Adam Tindle, Analyst

Got it, thank you.

Operator, Operator

Our next question comes from Saket Kalia with Barclays. Your line is open.

Saket Kalia, Analyst

Okay, great. Hey, guys, thanks for taking my questions here. Steve Trundle, maybe for you, can you 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 to change much in just one quarter, but curious if you could just expand on what you're seeing in a couple of those biggest growth businesses?

Stephen Trundle, CEO

Yes, the recollection about the first year is accurate. Last quarter, we mentioned that the growth businesses comprised around 30% of our SaaS, and we are seeing growth at approximately 25%. This trend has continued. A significant driver of this is EnergyHub, which we highlighted in a recent press release as having a record-setting year with over 1,800 demand response events called year-to-date on behalf of utilities. We've transferred more than double the gigawatt-hours of power off the grid at critical moments this year compared to last year, reflecting increased usage in that area, enabling ongoing growth for the business. The team is also actively working on expanding into the broader resource space, particularly with electric vehicles, which we view as another growth opportunity. Our international business is also progressing, maintaining a similar growth rate. Although the SaaS growth can be inconsistent internationally, we see many opportunities as we enter new relationships and assist partners in scaling and fully adopting our platform, transitioning from basic security offerings to comprehensive solutions that include video and automation. Additionally, we are making solid progress in our commercial sector, including intrusion, access, and video services, though it is still early in that segment. There was a slight slowdown in hardware sales through that channel in the third quarter, but overall SaaS growth rates have remained consistent. We anticipate this trend will continue and provide us with favorable conditions next year.

Saket Kalia, Analyst

Got it. Maybe for my follow-up, for you, Steve Valenzuela, so 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

Yes, that's a valid point. We have taken some legal costs into account. However, it's important to note that a significant portion of the legal expenses related to the major programs have now been adjusted out. Once they reach a certain stage, we've accounted for that in our adjusted EBITDA guidance.

Darren Aftahi, Analyst

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

Stephen Trundle, CEO

Yes, Darren, that’s what I was trying to convey. While it wasn't a significant pullback, it was noticeable. Starting around mid-August, we began to observe slower or delayed purchasing cycles, where orders that would typically close in three to four weeks were taking longer, extending into the next quarter. This seemed to happen mostly in the second half of the third quarter, where the pace of activity at the enterprise level, particularly with larger customers and retailers, slowed down a bit. We believe that many companies are currently assessing the overall economy and are deciding whether to adopt a more conservative or growth-oriented approach with their capital expenditures. This is our best interpretation of the situation. Consequently, we noticed a slight slowdown in that area during the third quarter.

Darren Aftahi, Analyst

That's helpful. Thank you. And then maybe one for Steve Valenzuela, your free cash flow 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, how should we think about free cash flow in the fourth quarter based on the implied guide?

Steve Valenzuela, CFO

Yes, Q3 was an exceptional quarter for cash flow. Everything aligned perfectly. We can't anticipate such performance to be routine. Q4 typically sees some seasonality regarding cash flow. In Q3, we benefited from favorable Days Sales Outstanding and a slight reduction in inventory. In Q4, there's also the possibility of tax payments related to the new tax rules concerning R&D capitalization, which may be necessary if Congress does not amend that rule. So, while Q3 was indeed extraordinary for cash flow, the year-to-date cash flow is around $90 million, and typically, cash flow for the year ranges from $90 million to $100 million. It was just that in Q3, we experienced a perfect storm that generated that amount of cash flow.

Matthew Bullock, Analyst

Hi. Awesome. Thanks. Yes, 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 Valenzuela, CFO

Sure. Hey, Matt. Yes. The EBITDA performance comes from 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 private 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 burdens would be, but I've got a budget for it at a week ago, 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 in the years. The year's not done, but I'd say it's been a little less intense than what I anticipated.

Matthew Pfau, Analyst

Okay, great. Thanks. I'll just ask for one more clarification on the legal expenses. There was a decent sequential uptick. What drove that in the quarter?

Steve Valenzuela, CFO

There is a lot of legal activity going on. As you can see, you'll be able to see 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 yes, 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, Analyst

Okay, got it. And then as we think about the hardware guidance for 4Q and for 2024, does ADT rolling off to its own platform have any impact on the hardware line, or is that just on the subscription line?

Steve Valenzuela, CFO

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

Operator, Operator

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