Earnings Call Transcript - ALRM Q3 2024

Operator, Operator

Good day, and thank you for standing by. Welcome to the Alarm.com third quarter 2024 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. To ask a question during the session, you will need to press star one one on your telephone. Then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that this conference is being recorded. I would now like to hand the conference over to your speaker today, Matthew Zartman, Vice President of Investor Relations. Please go ahead.

Matthew Zartman, Vice President, Investor Relations

Thanks, Kevin. Good afternoon, everyone, and welcome to Alarm.com's third quarter 2024 earnings conference call. Please note the call is being recorded. Joining us today are Steve Trundle, our CEO, 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, 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-Ks, which will be filed shortly 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 other information which speak as of their respective dates. In addition, several non-GAAP financial measures will be discussed on the call. A reconciliation of GAAP to 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 Trundle, Chief Executive Officer

Thank you, Matt. Good afternoon, and welcome to everyone. We are pleased to report financial results for the third quarter that exceeded our expectations. SaaS and license revenue in the third quarter grew to $159.3 million, and adjusted EBITDA was $50 million. Our performance in the quarter resulted from continued momentum across our growth initiatives. Sales of our video and access control products outperformed and contributed to hardware revenue that was above our expectations. We also saw a revenue retention rate increase to 95%, which is above our historical range. We believe two things are driving the revenue retention metric. First, our service providers have been increasingly putting in fully featured and more robust systems that provide value to the consumer or business owner every day. Second, the slower US housing market has reduced subscriber moves, which can be a leading cause of account churn. I want to thank our service provider partners and our employees for their contributions to our results. On today's call, I want to update you on a few new capabilities introduced to our commercial and residential video offerings before handing it over to Steve Valenzuela to cover our financials in more detail. In October, we hosted our annual customer conference, which we call Partner Summit, here in Washington, DC. The event again attracted a sold-out audience that represented a nice cross-section of our service provider partner community. We were able to feature several recently released products in our presentations during the summit. One of the products we demonstrated is a consumer-facing capability we call AI Deterrence, or AID. It can identify and engage a potential trespasser on a property and deter them from causing further problems. AID is integrated into our remote video monitoring solution and is essentially an AI bot that replaces some of the workload that a live operator monitoring the video camera would otherwise need to perform. It can discern clothing and location and deliver verbal warnings that are dynamically adapted to the intruder and the scene. Our goal with AID is to make our remote video monitoring solution as cost-effective as possible for our service providers. By augmenting human intervention and focusing humans on only the most critical events, we believe our partners can adopt our solution more aggressively and introduce it to a larger segment of the commercial and residential markets. Our advancements in applying AI to video streams in both residential and commercial settings benefit from our scale. In August alone, our AI-enabled video cameras identified and sent 1.2 billion events for further classification and verification via the cloud. Of these 1.2 billion events of interest, 700 million were verified by the cloud AI engine, triggering additional rules which can include archival or push notifications to alert subscribers of important activity. In September, our OpenEye business also launched a new line of cloud cameras designed for flexible, streamlined enterprise video surveillance installations. The new cameras are entirely self-contained with onboard storage and AI processing. They connect directly to the cloud and are provided as a subscription-based solution that leverages the full suite platform of management analytics, learning, and reporting tools offered by OpenEye. Cloud cameras provide a cost-effective way for our partners to land, and we are pleased with OpenEye's continued momentum and growth. OpenEye is on the cusp of surpassing one million active channels, or video cameras, on its software platform. We expect continued strong contributions to Alarm.com's growth as OpenEye leads the transformation of the enterprise security video management market from standalone on-premise devices to cloud-enabled AI-powered video solutions. As most of you know, we typically conclude our quarter with Steve Valenzuela providing an initial look at the following fiscal year. It is early, and we will continue to refine our plans and forecast before providing our more calibrated and official 2025 guidance on our fourth quarter call early next year. But I want to give a little context for how we are looking at 2025 at this point. As we think about 2025 revenue, a meaningful variable is the rate of ADT rolls out the ADT Google software. This forecasting dependency makes visibility into 2025 a bit more opaque than in prior years. Our first look numbers assume that ADT's corporate residential account production will fully transition to the ADT Google software and impact SaaS revenue growth for the entirety of 2025. Fortunately, we have built a diverse organic growth engine that will allow us to continue growing our business despite this long-anticipated headwind. We expect our EnergyHub business, our OpenEye business, our International business, and our Alarm.com commercial business, including our access control solution, to contribute to our consolidated growth rate at roughly the same levels in 2025 as in 2024. Meanwhile, we have moved EBITDA margins up some in the second half of 2024, and we expect current levels to hold as we move through 2025. In summary, I am pleased with our Q3 results and the continued growth we see across the business. I want to thank our service provider partners, our team for their hard work, and our investors for their continued trust in our business. And with that, let me turn things over to Steve Valenzuela to review our financials.

Steve Valenzuela, Chief Financial Officer

I will begin with a review of our third quarter 2024 financial results, then provide our guidance for Q4 and full year 2024, and conclude with our initial thoughts on 2025 before opening the call for questions. Third quarter SaaS and license revenue of $159.3 million grew 9.8% from the same quarter last year. Our SaaS and license revenue visibility remained high, with a revenue renewal rate of 95% in the third quarter, above our historical trend and higher than our long-term target range of 92% to 94%. Hardware and other revenue in the third quarter was $81.2 million, up 5.7% from Q3 2023, mainly due to increased sales of access control devices and video cameras. Total revenue of $240.5 million for the third quarter grew 8.4% year over year. SaaS and license gross margin for the third quarter was 85.5%, up slightly from 84.9% in the year-ago quarter. Hardware gross margin was 24.1% for the third quarter, up from 22.6% in Q3 2023, mainly due to favorable product mix. Total gross margin was 64.8% for the third quarter, up from 63.3% in the prior year quarter. Turning to operating expenses, R&D expenses in the third quarter were $62.2 million compared to $61 million in Q3 2023. We ended the third quarter with 1,164 employees in R&D, up from 1,116 employees in Q3 2023. Total headcount increased to 2,055 employees for the third quarter, compared to 1,986 employees in the year-ago quarter. Sales and marketing expenses in the third quarter were $27 million, or 11.2% of total revenue, compared to $23.9 million, or 10.8% of revenue, in the same quarter last year, mainly due to a modest increase in marketing program investment. Our G&A expenses in the third quarter were $25.7 million, down from $31.5 million in the year-ago quarter, mainly due to lower legal-related costs. G&A expense in the third quarter includes negligible non-ordinary court litigation compared to $5.9 million in the year-ago quarter. Non-ordinary court litigation expenses are part of our adjusted measures and are excluded from a measurement of our non-GAAP financial performance. In the third quarter, GAAP net income was $36.7 million, up 88% from GAAP net income of $19.5 million in the year-ago quarter. Non-GAAP adjusted EBITDA in the third quarter was $50 million, up 20.6% from $41.4 million in Q3 2023. Non-GAAP adjusted net income increased to $35.2 million, or $0.62 per diluted share in the third quarter, up from $30.6 million, or $0.56 per share for the third quarter of 2023. Turning to our balance sheet, we ended the third quarter with $1.17 billion of cash and cash equivalents, up from $697 million on December 31, 2023, with much of the increase due to the convertible offering we closed in May this year and, to a lesser extent, our positive cash flow. Our non-GAAP free cash flow for the three and nine months ended September 2024 of $74.5 million and $142.3 million, respectively, increased from $60.9 million and $90.7 million for the same periods in 2023, mainly due to higher profitability levels and improvements in working capital with declines in inventory and a reduction in accounts receivable days sales outstanding to 45 days. Turning to our financial outlook, for the fourth quarter of 2024, we expect SaaS and license revenue of $163.2 to $163.4 million. For the full year of 2024, we are raising our expectations for SaaS and license revenue to $628.7 to $628.9 million, up from our prior guidance of $626.8 to $627.2 million. We are now projecting total revenue for 2024 of $933.7 to $935.9 million, up from our prior guidance of $920.8 to $931.2 million, which includes estimated hardware and other revenue of $305 to $307 million. We are raising our estimate for non-GAAP adjusted EBITDA for 2024 to $174 to $176 million, up from our prior guidance of $165 to $167 million. Adjusted non-GAAP net income for 2024 is projected to be $125.5 to $126.5 million, or $2.25 to $2.27 per diluted share, up from our prior guidance of $119.5 to $120.5 million, or $2.06 to $2.07 per diluted share. EPS is based on an estimate of 57.9 million weighted average diluted shares outstanding. We currently project our non-GAAP tax rate for 2024 to remain at 21% under current tax rules. We expect full-year 2024 stock-based compensation expense of $42 to $43 million. Finally, I will provide some early thoughts on 2025, noting that these are preliminary. We currently estimate our SaaS and license revenue for 2025 to be between $668 to $671 million. Total revenue for 2025 could range between $975 to $980 million. As Steve noted, we are modeling the ADT ramps up to ADT Google rollout. We currently project our non-GAAP adjusted EBITDA for 2025 to be in the range of $188 to $192 million. We will provide our annual guidance for 2025 when we report our fourth quarter 2024 financial results early next year. In summary, we are focused on executing our 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

At this time, please press star one one on your telephone. 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, Analyst (Raymond James)

Okay. Thanks. Good afternoon. Please bear with me. I am just crunching the numbers as best as I can here, Steve. I wanted to ask on the SaaS guidance for fiscal 2025. I understand there are a lot of variables here, and congratulations on a strong Q3 that you are coming off of. If I am doing the math right here, I think you are going to finish this year at about 10.5% SaaS growth for 2024. And the initial look for 2025, I think, is closer to 6.5%. If you could walk through some of the building blocks on the delta between those two. I think ADT in particular, I think a lot of us had thought about somewhere in the neighborhood of 1.5% to 2% headwind related to that. But I wonder if, now that you have a little bit more visibility and clarity on that, could you explain the bridges from the strong finish in 2024 and the initial 2025 outlook?

Steve Trundle, Chief Executive Officer

Hey, Adam. This is Steve Trundle speaking. Keep in mind, we are not yet calling it guidance. We are going to do our full guidance after the fourth quarter, but in the initial look numbers, you are doing the math correct. There are really a couple of things there to point out. First is, as we have said in the past, we are anticipating about a 200 basis point headwind to growth on the ADT Google transition. So expect that to really start next year. And that is what we have modeled. The second one is that if you remember this year, we got a meaningful bump when we closed out some litigation. We had essentially no license revenue coming from IP licenses in 2023. And then we closed out litigation. We had a pretty meaningful bump off of that resolution this year. That IP license revenue is sort of straight-lined into the early 2030s. So we are not getting a bump there again this year, and that by itself is sort of another 200 basis points in the math. So if you add those two up, it sort of reconciles with the 10.5% that we are showing right now.

Adam Tindle, Analyst (Raymond James)

And maybe just a follow-up. You mentioned EBITDA margins and you expect current levels to hold. One quick clarification and a question on that. The clarification would be: I think you did about a 21% EBITDA margin this quarter, but the guidance implies 19%. So when you say current levels, I am assuming it would be off the kind of 19% of guidance, not the 21% you just did, but just clarifying that. And then secondly, Steve, as you think about holding those very healthy EBITDA margins, maybe you can speak about how you thought about the internal balance between growth and profitability. On one hand, you could invest more to bump up growth versus holding EBITDA margins where they are. How did you think about balancing investing more to increase growth versus holding current EBITDA levels?

Steve Trundle, Chief Executive Officer

Good question. Yes, the number we are guiding on and the initial look is the 19%. And I think what I said is we are going to hold things there. It might be a little above that if you do the exact math, a couple of 20 basis points or so above. And that is up from sort of where we have been the last couple of years. So that is a meaningful transition for us. The plan at the moment is we are constantly scrutinizing the way that we allocate capital, what things make sense, and what things have attractive return characteristics. Through time, those things evolve. Some businesses have grown nicely and are now reaching a scale where, as we look into the future, they begin to shift a bit more from pure investment mode to more mature contributors that return cash to the parent. We talked for a while about our various growth initiatives—specifically EnergyHub, the commercial business, and international. Each of those is now a bit larger than in the past and is beginning to contribute more. That left us comfortable that with their increased scale, we could shift more of the cash production capacity of the company into the EBITDA line, and we expect that to be the case going forward.

Operator, Operator

One moment for our next question. Our next question comes from Mason Marion with Jefferies. Your line is open.

Mason Marion, Analyst (Jefferies)

Hi. Thanks for taking the questions today. Your net revenue retention is really strong at 95%. Can you talk about some of the drivers there? You alluded to lower churn, but are you also seeing better cross-selling within your base?

Steve Trundle, Chief Executive Officer

I think it is a combination of fewer moves and the benefits from our video analytics. Churn is often driven by subscriber moves, and we have seen fewer moves. In addition, video with analytics is compelling and is enabling users to interact with the system every single day, which drives usage and retention. That can show up as cross-sell or upsell: a subscriber moving from an account without video to one with video creates a benefit, and if an existing video subscriber opts into a more advanced analytics package that also helps on the revenue retention metric. So there is a mix of factors. The reduction in subscriber moves is probably the main driver, but account characteristics and upsell activity are also contributing.

Mason Marion, Analyst (Jefferies)

Understood. And then I believe your EBS integration is largely complete now. Can you talk us through that? What has early feedback been? Are you seeing benefits from that acquisition?

Steve Trundle, Chief Executive Officer

Yes. We are on the cusp of beginning to see the rollout of the EBS technology and capabilities. As a refresher, EBS is a Europe-based business with expertise supporting a wide range of intrusion panels. We wanted to attack a part of the market beyond the new installs Alarm.com typically gets. The EBS low-cost communication product works with the Alarm.com back end now, and our belief is that we can add another 40,000 to 50,000 subscribers in rest-of-world markets next year using the EBS low-cost communication technology—subscribers we otherwise would not get. So it is beginning to contribute to growth on the international side.

Operator, Operator

One moment for our next question. Our next question comes from Adam Oshkis with Goldman Sachs. Your line is open.

Adam Oshkis, Analyst (Goldman Sachs)

Great. Thanks so much for taking the questions. Nice speaking with you both. Just curious how you are viewing pricing opportunities here, particularly around some of the cost savings that AI initiatives could provide for your customer base. How do you balance the ability to take price by allowing customers to manage cost more effectively versus this being a customer success tool to increase retention?

Steve Trundle, Chief Executive Officer

AI does provide some ability for cost optimization. As I mentioned in my prepared remarks, if we use AI Deterrence or an AI bot to replace some previously expensive human monitoring activity, we help our service provider partners reduce their cost to serve. That gives us some ability to price that capability in a way that benefits both parties. We work with partners to find the right pricing that works for them. We are careful not to price things at a level that restricts broad adoption; we prefer to be broadly applicable, which requires keeping costs at a level our partners can afford to bring to a broad segment of the market. With respect to pricing more generally, we monitor pricing opportunities in the normal course and there will be pricing increases as part of the plan, but the AI piece is particularly interesting right now because it can both reduce partner costs and enable broader adoption.

Adam Oshkis, Analyst (Goldman Sachs)

Okay. Great. That is really helpful. And then could you refresh us on the top-of-funnel opportunity on the commercial side? Where is the rest of the market, and how do OpenEye and other investments open up conversion opportunities over time?

Steve Trundle, Chief Executive Officer

Demand on the commercial side looks fairly constant, perhaps picking up slightly based on what we are seeing. We saw increased demand on the access control side and had a meaningful beat on hardware this quarter, some of which was driven by access control. Often those solutions are sold and pull through video. We attack the commercial market through integrators for the high enterprise side, through regular service provider partners in the mid-market, and with some demand generation activity. Everything we are hearing and seeing suggests the commercial market is slightly better than earlier in the year. OpenEye's cloud cameras and the enterprise solution help convert opportunities, as they provide subscription-based, cloud-enabled, AI processing and analytics that many customers want.

Operator, Operator

Thank you. Again, ladies and gentlemen, if you have a question or comment, our next question comes from Matt Treleck with William Blair. Your line is open.

Matt Treleck, Analyst (William Blair)

Hey, everyone. You have Matt Fleuk on for Steven Sheldon. Thank you for taking my questions. Starting with hardware: given the strong performance this quarter, what would it take to see hardware revenue return to growth in 2025, as I think the early look expectations imply more flat growth in 2025?

Steve Trundle, Chief Executive Officer

At the moment, we are sticking with our initial look estimates on hardware revenue. If we saw unexpected strength on the commercial side, or if the ADT Google rollout dampened less than expected, that could result in more hardware sales and upside. The biggest potential upside would be more takeoff on the commercial side of the business. Our model and the forecast we presented reflect the best information we currently have, but there could be upside if commercial demand is stronger than anticipated.

Matt Treleck, Analyst (William Blair)

Got it. That is helpful. And then on R&D priorities over the coming year, are there capabilities you are focused on building out, or is it more about enhancing the existing product catalog?

Steve Trundle, Chief Executive Officer

We are focused on building out new capabilities, particularly in video and analytics. That includes new form factors and different cameras; at Partner Summit we previewed a couple of new form factors and battery-powered camera technology we are excited about. We previewed the EBS integration with international partners and are pleased to be rolling that out. These efforts are focused on the markets where we are already active—the commercial, residential, and international markets—and we do not plan to enter a completely different market next year.

Operator, Operator

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

Darren Aftahi, Analyst (Roth)

My questions are twofold. I think earlier this year you talked about an 18% EBITDA margin. Why the pivot now to a higher expectation? And second, you talked about headwinds to SaaS growth for 2025. Where might things go right beyond commercial—which you mentioned—that could counterbalance those headwinds?

Steve Trundle, Chief Executive Officer

Good memory. Earlier we talked about 18% at the end of the year. As our growth initiatives have reached a larger scale, we are comfortable forecasting EBITDA margins in the 19% plus range next year, and we do not envision moving backwards. Regarding potential upside to SaaS growth, there are a few possibilities: landing a new large logo domestically or internationally, corporate development activity that adds growth, or increased acceleration in international markets. The challenge is we are looking five quarters out with our initial look, so we focus on factors that are more certain. There could be upside if any of those elements materialize.

Operator, Operator

One moment for our next question. Our next question comes from Jack Van Dardey with Maxim Group. Your line is open.

Jack Van Dardey, Analyst (Maxim Group)

Thanks, guys. Nice results. Looking at your 2025 initial SaaS outlook, for Steve: on the international side, do you plan to grow the number of service providers you currently have in international markets? Is that assumption baked in? Also, are existing international partners expected to grow, or are they assumed to be flat? Can you dissect that a bit for the 2025 outlook?

Steve Trundle, Chief Executive Officer

We are fortunate to have a strong set of anchor service provider partners internationally, including most of the major enterprise names. We continue to add partners, and we are building out a base of smaller service providers in many markets. There are still some markets where we are not particularly active yet, and we are working on those. We are adding partners on the international side at a faster clip than domestically, where we are more mature. When we add a partner, it usually takes at least a year, often a couple of years, to reorient their business around Alarm.com and for the revenue to flow into our P&L—so there is latency. In our 2025 outlook, we are not assuming the addition of new logos at this point; our model is based on known items. New logos would create upside, but the effects take time to materialize.

Jack Van Dardey, Analyst (Maxim Group)

Got it. Very helpful. Can you reiterate the 2025 SaaS outlook range again? I missed the ceiling earlier.

Steve Valenzuela, Chief Financial Officer

Yes. The range for 2025 is $668 to $671 million.

Jack Van Dardey, Analyst (Maxim Group)

Gotcha. Very helpful. Much appreciated. Thank you, guys. Good results again.

Operator, Operator

And I am not showing any further questions at this time. Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.

Steve Valenzuela, Chief Financial Officer

Thanks.