Alarm.com Holdings, Inc. (ALRM) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Alarm.com Second Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to hand the floor over to Jonathan Schaffer with Blueshirt Group. Please go ahead, sir.

Thank you. Good afternoon, everyone, and welcome to Alarm.com's 2017 Second Quarter 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. Before we begin, a quick reminder to our listeners. During today's call, management may make forward-looking statements, which may include projected financial results or operating metrics, business strategies, anticipated future products and services, anticipated investment and expansion, anticipated market demand or opportunities and other forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements. Actual results and the timing of certain events may differ materially from the results or timing predicted or implied by such forward-looking statements, and reported results should not be considered as an indication of future performance. Please note that these forward-looking statements made during this conference call speak only as of today's date, and the company undertakes no obligation to update them to reflect subsequent events or circumstances, other than to the extent required by law. Please refer to our SEC filings as well as our financial results press release for a more detailed description of the risk factors that may affect our results. Also during this call, management's commentary will include non-GAAP financial measures. Reconciliations between GAAP and non-GAAP metrics for our reported results can be found in the tables of our earnings press release, which we have posted to our Investor Relations website at investors.alarm.com. This conference call is being webcast and is also available through the Investor Relations website. So with these formalities out of the way, I'd now like to turn the call over to Steve Trundle. You may begin.

Thanks, Jonathan, and thanks to everyone for joining our call today. I am pleased to report that we continue to deliver solid results this quarter. Our SaaS and license revenue in the second quarter was $58.9 million. This is an increase of 40% from a year ago and includes the first full quarter contribution from our acquisition of Connect that we closed on March 8 of this year. Our non-GAAP adjusted EBITDA in the second quarter was $15.9 million, up 31% over last year. Throughout the quarter, our team continue to focus on delivering innovative solutions for our service providers and their customers. We expanded the Alarm.com platform with new connected devices that will facilitate the deployment of our services and help drive customer engagement and retention, and we continue to integrate Connect and Piper into our operations. Let me begin by discussing some of the enhancements we made to our video product portfolio. Last year, during our first quarter call, I described our strategy for expanding our portfolio of video cameras, such that we can engage a wider set of customers and continue to drive higher video attachment rates. Since that time, we have made good progress on this plan. We successfully added a video doorbell suite that many of our service providers have rapidly integrated into their sales, service and installation routines. We also expanded our portfolio of video cameras. This past quarter, we introduced 2 new residential cameras: the Alarm.com 522 and 722 series indoor and outdoor cameras. These new indoor and outdoor models offer increased capabilities for a superior overall user experience. We improved both the image resolution and performance in high-contrast lighting environments. Importantly, both cameras also have increased onboard computational power for processing advanced video analytics that we plan to deploy, over time, to both new and existing customers. We also introduced new commercial-grade video cameras during the quarter. The Alarm.com 725 and 825 cameras offer performance characteristics and price points aligned for smaller sized properties within our target market of small- to medium-sized businesses. These new cameras round out our existing portfolio and allow our service providers to engage a wider range of commercial customers with their video services. In addition to the new video cameras, we also integrated a new commercial-grade security panel, the 2GIG Vario and a new version of our system enhancement module, which enables existing small- and medium-sized businesses that use the DSC PowerSeries control panel to work with Alarm.com. We believe that these and other investments we are making in our commercial offering will help us broaden our addressable market. And as the year continues to advance, I expect that we will bring additional commercial capabilities to market. Next, I want to spend a moment on the suite of back-end services and tools that we provide to our service providers to help them more effectively market, install and support our solutions. We refer to these resources as our growth and productivity services. On last quarter's call, I spoke about our deployment of business intelligence to help our service providers optimize their businesses to drive greater customer loyalty. Another key program is our CRM layer called Customer Connections. Last year, during our Q1 call, I introduced Customer Connections to you shortly after we had launched the program. In the year since, we've added many additional pre-configured campaigns that our service providers can use to engage with their customers to generate up-sells, generate referrals and drive further consumer engagement. Our service providers can now even use Customer Connections to campaign to their base of customers who do not have Alarm.com services. Today, more than 1,400 of our service providers participate in our Customer Connections program, and more than 900,000 of their customers are enrolled. I also want to update you on the progress we're making on the initiatives that we report in our Other segment. While these initiatives are still early-stage opportunities, I'd like to highlight them occasionally as we believe they demonstrate the full reach of our platform. One of our subsidiary initiatives, PointCentral, offers an enterprise-grade property management and unattended access solution. Their market includes vacation rental properties, residential REITs and businesses requiring unattended delivery solutions. One of their partners is a leading residential REIT with a portfolio of more than 30,000 properties. As this customer has begun to deploy PointCentral's unattended access solution to its properties, they have seen a significant increase in the productivity of their leasing consultants. More than 60% of prospective residents now choose to sell show properties. Potential tenants can select a convenient time based on their own schedules without having to schedule with the leasing agent. An additional side benefit of the deployment has been reduced utility bills as they also deployed our energy management solution. Finally, before I turn things over to Steve Valenzuela, I also want to update you on our integration of the Connect and Piper business units, which we acquired from Icontrol Networks in Q1. We have now had a few months to examine the businesses, meet with customers and employees and learn their operations in more detail. We feel like we have a strong base of key team members in place, and we've initiated several joint development projects with the Connect and Piper teams, as we seek to add velocity and scale to our R&D operations. At the same time, we are very focused on meeting the current and future needs of the key customers of these new units. To conclude, we are pleased with our results and achievements in the second quarter. Our team continues to execute on our growth plans and our focus remains on providing innovative solutions to our service provider partners. With that, I'll turn the call over to Steve Valenzuela, who will review our second quarter 2017 financial results and provide updated guidance for 2017. Steve?

Thank you, Steve, and good afternoon, everyone. I will begin with a review of our second quarter 2017 financial results and then provide initial guidance for the third quarter and our raised outlook for full year 2017 before opening the call for questions. SaaS and license revenue for the second quarter grew 40% over the same quarter last year to $58.9 million. This includes the first full quarter revenue contribution from Connect, which is in line with our expectations that we outlined when we closed the acquisition. Our SaaS and license revenue visibility remains high with a revenue renewal rate of 93% in the second quarter, consistent with our revenue renewal rate last quarter and the same quarter last year. Hardware and other revenue in the second quarter was $27.1 million, an increase of 21% year-over-year. This increase was largely driven by strong sales of our new video cameras and the new Slim Line Edition of our video doorbell that we introduced in the second quarter, which outpaced our expectations. Total revenue for the second quarter increased 33% over the same quarter last year to $86 million. Gross margin for our SaaS and license revenue was 86% for the second quarter, up about 250 basis points from the same quarter last year. This is mainly due to Connect, which has a higher gross margin percentage than Alarm.com as we have previously discussed. Hardware and other gross margin was 21% for the second quarter. This is up about 100 basis points from Q2 2016 and down about 140 basis points sequentially due to a combination of product mix and costs related to the introduction of our new video and doorbell products. Total gross margin was 65% for the second quarter, up about 100 basis points sequentially from the first quarter and up about 400 basis points from the same quarter last year. The higher gross margin in the second quarter is due to a combination of higher SaaS and license gross margin and a higher mix of SaaS and license revenue accounting for 68.5% of total revenue for the second quarter compared to 65% in the same quarter last year. Turning to operating expenses. R&D expense in the second quarter was $20.1 million compared to $10.8 million in the second quarter of 2016. We ended the second quarter with 457 employees in R&D, up from 290 employees a year ago. Sales and marketing expenses in the second quarter were $11.9 million or 14% of revenue compared to $9.9 million or 15% of revenue last year. G&A expenses in the second quarter were $13.5 million, down from $14.2 million in the year-ago quarter. G&A expense includes non-ordinary course litigation expense of $1.3 million in the second quarter compared to $4.7 million in Q2 2016. Non-ordinary course litigation expenses are part of our adjusted measures and are excluded from non-GAAP adjusted EBITDA. Non-GAAP adjusted EBITDA increased to $15.9 million in the second quarter, up 31% from $12.1 million in the same quarter last year. In the second quarter, GAAP net income was $9.9 million and non-GAAP adjusted net income was $16 million. Our tax provision in the second quarter was a favorable benefit to net income in the amount of $4.5 million. This tax benefit is a result of the combination of additional R&D tax credits and a favorable impact from the new accounting standard for employee share-based payments from employee stock exercises in the quarter. We are required to recognize the tax windfall benefits in the quarter employees exercised stock options under the new accounting standard, and this will cause our effective tax rate to vary from quarter-to-quarter. Turning to our balance sheet. We ended the second quarter with $68.9 million of cash and cash equivalents. In the second quarter, we generated approximately $11.8 million in cash flow from operations and $8.7 million of free cash flow. Turning to our financial outlook. We are providing initial guidance for SaaS and license revenue for the third quarter of 2017 of $60.6 million to $60.8 million. For the full year of 2017, we are raising our guidance for SaaS and license revenue to be between $233.3 million to $233.8 million. This compares to our prior outlook for SaaS and license revenue of $231.7 million to $232.7 million. We are also raising our guidance for total revenue for 2017 to $326.3 million to $327.8 million, up from our prior guidance of $322.7 million to $325.7 million. This includes our raised guidance for hardware and other revenue of $93 million to $94 million. We are also increasing our expectations for non-GAAP adjusted EBITDA for 2017 to be between $66.5 million to $67.3 million, up from a prior range of $65.5 million to $66.5 million. We are also raising our guidance for non-GAAP adjusted net income for 2017 to $47.5 million to $48.3 million or $0.96 to $0.98 per diluted share. This is based on an estimate of 49.4 million weighted average diluted shares outstanding. We expect full year 2017 stock-based compensation expense of $7 million to $7.5 million. In summary, we are pleased with our results for the first half of 2017. We are focused on executing on our business strategy and investing in our growth opportunities while continuing to deliver solid financial results. With that, operator, please open the call for Q&A.

[Operator Instructions] And our first question for today comes from the line of Michael Nemeroff with Credit Suisse.

Steve Trundle, have there been any material updates regarding your relationship with ADT? Obviously, the long-term goal will be to replace Connect with Alarm. But in the near term, is there any functionality that you can also layer on top of the existing Pulse base to increase the monetization opportunity?

Yes. If there were really material developments, we would obviously put those out. So there's nothing material that we haven't updated on. In terms of the relationship, we're working, taking our direction from ADT. And as I've said in the past, do have the goal of increased synergies between the 2 platforms. So there are certain capabilities, for example, that may exist in the Alarm.com platform such as the - what we call the lifetime value builder, the ability to present existing customers with offers on how they can expand their system. And I think it would make a lot of sense and obviously, be in line with the goal that I think we and ADT would share to take that type of capability and look for ways to fold that into the experience that the existing Pulse subscribers are getting. So there are lots of discussions about that sort of thing, and I wouldn't necessarily say, hey, we're going to absolutely replace Connect. But the goal really is to look for opportunities to move towards a single platform, at least in terms of capabilities, look for more synergies on our side between our team and the team - the solid team we've inherited in Redwood City, and it will take some time to unfold. But certainly, if there were anything absolutely material, we would have to put that out.

That's helpful. And then, Steve, I'm kind of curious, for the last couple of quarters, you've said that the video doorbells and cameras have performed above expectations, and that's been obviously driving the hardware beats. What's the penetration of those video doorbells and cameras in the existing subscriber base? And then on those video cameras, the new ones that you're putting out with enhanced capabilities, how should we think about refresh cycle? Do you typically see customers replacing with newer cameras? Has that happened in the past?

Good question. Yes, so the doorbell camera has surprised us a bit. It had been really a driver on a lot of new activations. I believe that we're seeing doorbell go on about 1 out of 8 every - 1 out of 8 installations at the moment, so call that 12.5% or so. And then, that, combined with some of the new cameras that I spoke about a moment ago, is also driving a higher attach on new installations with video, more like 1 out of 5 at this point up from, I think, maybe a year ago it was about - that number is more like 12%, 13%. So we're seeing some positive trends there and it's been part of our strategy to try to drive some of the costs out of the camera lineup, make it more accessible to our service providers and then the consumers adopting. As far as upgrades to the camera, we haven't seen a lot of that. The cameras are designed to work for a long period of time. So if they're working as designed, the customer should not need to replace them for any sort of reliability issue. I think we may begin to see some though, because the quality of - the image quality and the night quality capabilities in the new lineup are substantially better than what we were putting out 2, 3 years ago. And then the processing capability on board the unit allows us to support, as I noted, a higher degree of analytics. So there will be some functional reasons that I think a customer may want to upgrade going forward. But to date, we have not seen a lot of upgrades there.

And our next question comes from the line of Nikolay Beliov with Bank of America.

You noted in your prepared remarks your progress in video and the M&A integration. I was wondering if you can give us an update on the international strategy and uptake you're seeing with your large partners in Europe.

Yes. So in our international, I didn't comment as much on that this quarter, but we continue to make progress. I think we have now launched, I think I noted we would launch and I believe we have launched with - in Europe with Securitas in Belgium, the Netherlands and Norway. We haven't yet rolled in Iceland or Sweden. But those are on the near-term docket. We're also working with other prospects in Europe or existing actually already signed dealers. We have activity in the U.K., Ireland, Spain on the commercial side. But more generally, internationally, I think what we're seeing is some of the markets that I haven't talked about maybe quite as much like LatAm, are beginning to pick up a little bit of speed. The release of the SEM product for PowerSeries panel should help us there some. And the product is beginning - when I say product, in this case, I mean really the hardware products. So we're getting a little closer to being dialed in on a configuration of hardware products that we can reliably take forth to our service provider partners and rest of world. And I think, therefore, we may be getting a little closer to turning the quarter - turning the corner. Functionally, we're seeing strong contribution from ADT Australia and solid contribution from New Zealand as well. So it's moving along. We're not going to update every quarter on exactly where we are, but the total number of subscribers at this point is up about 100% versus a year ago. So we feel like the team is making solid progress, and we'll keep plowing ahead. And it takes a while to build momentum, but it's making progress.

And my second question is around the growth margin framework with EBITDA within the long-term framework you guys provided in the past. How do you think about the trade-off? What are the puts and takes at this point?

Well, the trade-offs. I'll start because the trade-off is kind of a conceptual question, which is we always think about growth versus EBITDA margin at some level, and we feel a responsibility to deliver a certain amount of EBITDA margin for the business. I feel like that forces us into a set of good habits. At the same time, we feel like it's still fairly early days with the deployment of Internet of Things. We've got lots of growth opportunities in front of us, places we can broaden the platform to take advantage of other segments. And therefore, we lean towards making rational growth investments and we'll do that in the near term, next couple of years, at the expense of absolutely optimizing what we could do with EBITDA margin.

Nikolay, I would add - this is Steve Valenzuela. If you look at for the guidance we provided for the year, we're coming in at 20.5% EBITDA margin, which is actually right within our long-term target we laid out at the time of the IPO about 2 years ago. At that point, we had indicated the target margin, EBITDA margin of about 20%, 25%.

And our next question comes from the line of Gabriela Borges with Goldman Sachs.

Well, Steve Valenzuela, I'm hoping you can remind us a little bit on the pricing impact and the ultimate impact on your business model as you get higher attach rate from things like video doorbell. Maybe you can just walk us through how at the consumer level the pricing model changes and how they get passed through your P&L with an impact to ARPU by your distribution channel?

Yes. Gabriela, it's Steve Valenzuela. Steve Trundle will probably add in here as well. But I think the way we look at this is the video attachment certainly is a positive. It certainly draws attraction and retention for - to the subscribers. We don't look at it necessarily as a driver of ARPU by itself because there are different levels of layers of different pricing models that we have. But it's, overall, it's a net positive, maybe slightly up in ARPU. But typically, ARPU is not the key guiding measure for us in terms of a metric.

So I think I would just reiterate what Steve said, which is, yes, higher attach on video is good for business. In addition to - the more value we're providing to the consumer at the end of the day, the more pricing power we have. At the same time, we have to recognize that we're in a competitive market and the consumer has choices, and we need to make sure that our service providers remain very competitive. So we try to sort of juggle those 2 requirements of shifting up ARPU versus keeping our service providers competitive. But you can think about it as opening up another window of opportunity for us to broaden the footprint of the application. There are things you can do with video data that we couldn't do solely with sensor data, so we like the deployment on that front. And it definitely kind of gives us a positive contributor to helping us maintain or, in some cases, slightly increase ARPU.

That's very helpful color. And as a follow-up, if I may. Steve Trundle, I'd love to get your updated thoughts on competition and particularly whether you see anything incremental out of Comcast. The other pieces that I want to get a little more color on was, as you get more video discussion amongst nontraditional competitors or other tech companies, can you look back and maybe expand your TAM from the 23 million households that traditionally bought security services, that's maybe something bigger than 23 million?

Yes. So those are 2 distinct questions. I particularly like the second one. But with the first one related to Comcast specifically, Comcast continues to be a solid competitor in the market. In the areas they service, they compete with our service providers aggressively. They are good marketers and they have a base of subscribers to market to. So I think in their last quarterly call, they portrayed that they continue to make progress in the home security and automation market. And we definitely continue to see them as a competitor to our service providers and therefore, a competitor to us. We're not seeing them as much really in what I would characterize as more as a wholesale or B2B market yet. I think they're focused on that application as a lever in their business. And to some degree, a little bit more in the cable industry than on the market we service - the capability needs that we service, or the capability needs of the type of service provider we do business with are quite a bit different than the capability needs of a typical MSO. So that's what we see there. With regards to the second question, it's a question that I don't think - and I'll rephrase the question which is, with the competition we're seeing from new entrants and others that are bringing IP video solutions directly to the consumer typically for self-install, are we seeing that more as competition or more as a gateway to a bigger TAM? And I don't think we actually know the answer to that question. I think we can be optimistic that people who have become acclimated to observing their property remotely will, at some point, want the highest quality solution they can put their hands on. And I think the highest quality solution will come from an Alarm.com service provider. So in that regard, you could argue that what we currently characterize as competition, something like a camera coming from a company that may sell it through retail is, in fact, TAM expanding. But I think it's too early for us to say that definitively. It would be an optimistic case, but not something we can state as actually being certain at this point.

And our next question comes from the line of Bhavan Suri with William Blair.

I guess, maybe to both Steves. But maybe Steve Trundle, I'll ask first. You're focused a lot more and you talked how much it is than a lot more around commercial. And you've outlined the markets about $4 million - or 4 million properties or opportunities or locations, I should say. A little bit of color, I guess, would be great in sort of - given sort of your incremental conversations around that, are you seeing a faster go-to-market there? Are you seeing acceleration in adoption there because of the video products and the analytics offerings in that space? How is that market different? We've talked about some of the dealers having the same space, sort of it feels like you're more excited about that market. I just love to get a little more color about why and are you seeing sort of business there accelerate?

Yes. I don't know if I would say we're more excited about it, except that it's a vector of growth for us. It's a market we haven't done a great job servicing historically. It does represent - if you define our North American TAM as monitor security and you pile on another 4 million to 5 million monitored properties, you do get 20%, 25% TAM expansion there, which is attractive to us. I think that we're updating on that because we have made some R&D investments there that are long term in nature that we think will yield results over time. The other reason to expect there in this particular segment is when we look rest of world, I often try to look at things that we're doing domestically and then assess whether their impact rest of world is higher than here in the U.S. or lower than in the U.S. under that premise that at some point, whatever we do here will follow into the rest of world market. And when you look rest of world, commercial is a more meaningful chunk of the addressable TAM. Rest of world, even that it is here in North America. I think North America, if we define TAM as market security, which probably is a little bit of a narrow definition, but residential's pretty solid here versus rest of world. But when you get rest of world on commercial, we think the TAM is meaningfully bigger than it is here in the U.S. So we want to make sure we're preparing ourselves with the right capabilities to, over a long period of time, grow in that domain as well. But we are seeing growth. I think we're seeing - we're figuring it out as we go. We've got a nice set of products now. We've enhanced those this past quarter. We've got some additional enhancements that we're working with our service providers to define and bring out before the year-end, and therefore, are pleased to indicate that we think it's something that will continue to help us meet our growth objectives.

That's helpful, Steve. I guess, one quick follow-up. The 2 things you point out different a little bit was commercial and then Piper. We've discussed Piper in the past you should have said "we'll see how that plays out." DIY, the WiFi connection, the competitive nature in that space between Apple and potentially, Amazon and Google and others is interesting. But you've obviously focused on Piper and you brought up Piper. Just a little bit on how you're thinking about attacking that space. DIY historically has been a space that you guys sort of said, it's interesting, but we're sort of really focused on dealer channel. I'd just love to understand, again, a little more color in sort of the way you did with commercial about why that seems interesting now and sort of the differentiation that Alarm brings to that space vis-à-vis, say, 6 to 12 months ago.

Sure. Yes. So this quarter, I haven't yet said anything about Piper, but I will go ahead get started. As folks know, Piper is 1 of the 2 business units that we acquired from Icontrol on March 8. Business has been focused historically on a retail-based, all-in-one monitoring product sold direct-to-consumer. We've had a few months now to acclimate ourself with the business and with the team. We like the team. The business, as it relates to their current product, will continue to sort of operate as is. Longer term, though, my conviction is still around the service provider channel, and therefore, when I look at how we allocate R&D investment dollars, I tend to favor my conviction. And therefore, I would expect that with Piper on a going-forward basis, we're hoping to take a lot of the talent that exists there and continue to operate what they have today for the foreseeable future. But we allocate some of the forward-looking focus on elements that we believe can be more synergistic with our global service provider channel. So that's where we're headed there.

And our next question comes from the line of Mike Koban with Raymond James.

This is Mike on for Tavis McCourt. I just had a couple kind of housekeeping questions, to be honest. I think you guys had said or suggested in the past that Connect and Piper or maybe just Connect - This is going to be my question. I think you suggested that it would contribute about mid-30s million dollars to revenue per year. Can you confirm that or set me straight?

Mike, this is Steve Valenzuela. At the time of the acquisition, we gave a 12-month forward look, if you will, of about $33 million to $37 million just for Connect for the following 12 months from the acquisition.

Okay, okay. Great. And then, Mike, is there - are you expecting any kind of seasonality out of that? Or is it fairly consistent?

It's fairly consistent. But I think at the time when we gave this guidance, we did say that's over 12 months and you should expect a ramp-up, so it's not going to be linear.

Got it. Great. And then finally, just on the tax rate the - for this year it blipped in a little bit. Would you mind walking me through what happened with the tax rate this quarter? And what's your kind of forecasting or incorporating in your forecast for the full year?

You're really going to make me do that? I will say I'll turn it over to Steve Trundle. Just kidding. Yes, so you're probably familiar. There's a number of things going on in Q2. One thing that's going on in Q2 is the adoption of the employee share-based payments to the new accounting standard. And I won't get into all of the accounting. But effective for January 1 for all companies, some companies have early adopted, we adopted January 1. It basically means each quarter, you effectively have to take into consideration your employee stock exercises and you have to take the tax benefit of that in the quarter that the employee exercised stock. So in Q2, we did have a lot of employee exercises. We had some in Q1 as well, so that was part of the reason for the $4.5 million tax benefit in Q2. Also, as we said in the press release and in my script as well, we did also have the benefit from R&D tax credits. We have a benefit both that goes back to 2016 that we trued up as well as the additional R&D tax credits for 2017. And that's really factored on the amount of R&D that we're investing, and we've been doing a very good job of growing our R&D. So we're able to take advantage of that through the tax credit, if you will, tax benefit. And then in terms of your second part of that question, which is what's the outlook for the tax rate for the year. I need to say that as we indicated as well, the employee share-based payments will cause the tax rate to vary from quarter-to-quarter. If we look at the tax rate for the rest of the year, just based on the end of Q2, we're projecting about a favorable tax rate of about 15%. So it's essentially a negative or a minus 15%, which is actually a positive. Now keep in mind, that's not going to be the actual tax rate too because there will be additional employee share-based kind of benefits throughout the second half of the year, which will change the tax rate. But just as we modeled it at the end of Q2, given what we knew then, we're projecting about a favorable 15% tax rate for the year. So hopefully, that helps you.

And our next question comes from the line of Jeff Kessler with Imperial Capital.

One of the things that is going on with - in the public and private companies that I cover in your business is the movement on their part toward trying to report more and more in terms of Pre-SAC EBITDA and less emphasis on things like a steady state in operating cash flow even though the bankers will continue to use it and RMR because there's profitable and unprofitable RMR. But Pre-SAC EBITDA implies much - a lot of emphasis on the services side of the business of these companies. How are they - how efficient are they, how longer are they keeping their customers, et cetera, et cetera. What are you doing to move along with your clients as these types of metrics are becoming more important in the way they are going to be judged in their business. You're going to be on the spot, to some extent, to help them make those numbers look better. And you, obviously, are involved in doing that because they depend on you.

Yes. Excellent question, and it really gets to the gist of why you need a solid platform to provide reasonable service to the service providers. If they're attempting to optimize on Pre-SAC EBITDA, then there are a few drivers. You mentioned a couple. One is you drive attrition down or whatever you can do to drive attrition down is helpful. On that front, we have launched the business intelligence offering, we've had that out for a while, trying to give them a much more transparency into the levels of engagement with the customer base. And from that, the customer's propensity to pay, if you have a customer that's not engaged, it's not atypical for that customer to make a call and say, hey, I'm not using this. Can I terminate? Oftentimes, the happy medium is customer may not terminate, but may sign up for a lower rate, which, of course, would affect their performance. So we want to try to help them on that front. We launched Customer Connections, which I referenced in my remarks about a year, a little over a year ago. Have seen nice uptake there. That gives us a tool whereby we can actually, on behalf of the service provider, reach out and touch on a periodic basis with a personalized message, all of the service providers subscribers and keep them aware of all the changes that we're making each week to the platform to make it better, again, with the goal of driving more engagement. And then the last I haven't spoken about recently, but as you talked to others in the industry, a lot of it gets to how efficiently can they actually service their customers. So how efficiently when a call comes in at 8 p.m. at night with someone that has a control panel that's beeping, can they handle that? Do they need to escalate it? Roll a truck? Or can you log into a mobile app from your home if you're a service provider and make a configuration change to the control panel such that, that issue goes away. One is far more efficient. One approach than the other, and one approach yields a happier customer than the other. And luckily, we, from day 1, have focused pretty heavily on how we would service the customer ourselves if we were in the shoes of our service provider. And that's driven us to create a lot of remote management capabilities. And we expose those capabilities directly to our service providers through something we call our FX and through an application we call Mobile Tech, but we also expose it through a set of API. So going forward, as we deal with larger and larger customers, taking more of that functionality and exposing it through interfaces that their staff can directly operate against using whatever internal application they may use interface to their customers is a big part of our focus? And I think that also will help them with the Pre-SAC EBITDA metric. So that's a little bit of color on that, Jeff, but if there's something else, I can try to hit it as well.

Sure. I can get you later on other things. Another, I think you call it buzzword, but another thing that is now being discussed in the industry going way past just your - going with just your clients is a notion of a, we'll call it a curated home automation system, one that essentially is much more integrated, one in which is built upon one app working well with the next app, working well with the next app. And I'm wondering what you're doing in that regard to provide your clients with a much more, let's call, a - but we'll call it a "curated system."

Right. No, and that's always - on that front, we're sort of trying to do what we've always done, but do it better. We've always had the view that what we put out is a curated home automation ecosystem, whereby each product that we integrate with works with the other products that we also support seamlessly through a single app. So we're not huge fans of making the user switch from app to app. Use this app if you want to open your garage door. Use this app if you want to control your security system. And there's multiple reasons for that. But one is that each time you force them into different application environment, the customer needs to redundantly replicate all their contact information their alerts don't work together. If my garage door is on a different app, then my security system, it's hard to make the garage door closed. When I arm the security system, things of that nature. So we do view that it - has a view that it should all work together and because of that, we're forced to be selective on the hardware that we add to the ecosystem to sort of maintain that state. As we go forward, I think that there's always an opportunity to do that better. So that sounds relatively easy to provide that curated ecosystem, but the consumer is demanding more and more devices and control of more and more things. So there's kind of constant pressure to add to the ecosystem. And every time you add, you're sort of exponentially increasing the test load of making sure that all of this can work together, and that's why you're seeing us continue to invest in R&D, so that we're at a fairly solid pace. So that we can make sure we're able to bring that to consumer. But that's a level of differentiation that we hope that we can fulfill and that we can enable our service providers to message with confidence.

Okay. If you've been involved with - you've been involved with Verizon on their G4 LTE program for now sometime. What type of traction are you getting with any of your customers to have them get up to a G4 level, and in doing so, increase the encryption and the, what I call, the hardness of their security, so that the buzzword of security hacking home systems gets a little bit harder to do when you get into a higher-end system - higher-end communications protocol like this.

Right. So the adoption of LTE is - has been pretty fast of late. A lot of service providers, some of the larger ones, have almost mandated that all installations be 4G. And they're doing that - at the moment, I would say less for the encryption benefit and more for the life of account benefits. With 4G, obviously, the half-life of that offering is essentially longer, gets us out at least a decade, probably essentially longer. So we're seeing a shift there. It's a place where we led the market. I think even today, some of our competitors are not out with a solid LTE offering. So we've been pushing it and it's being adopted. With regard to hardening the security system itself, most of the capabilities that we enable through LTE are capabilities that we, in some form, have historically enabled as well So I think the wireless connection has always been a fairly robust and hard connection. I think a lot of the things you may see in the press are related to the RF, between the sensor and the control panel, where we've seen evidence of playback attacks, of breaking into an encrypted sensor communications. And most of that effort or onuses not necessarily on our shoulders, but is instead on the shoulders of our control panel partners. And I think the service providers are gradually demanding that the sensors and peripherals that they deploy speak with a RF that, that is hardened so that they don't have sort of the PR risk of an attack that could come if that's not all encrypted. So that's kind of what we're seeing. That drives us to support more panels, more receivers. But the wireless piece between the control panel and ourselves has always been pretty hard.

And our next question comes from the line of David Gearhart with First Analysis.

I was just wondering if you could provide an update on the HVAC channel, the Building 36 product and what you're seeing there in terms of leveraging that channel to sell more smart home products.

Sure. This is Steve speaking. So it continues to be a focus. And I expect sometime over the next 3 or 4 quarters, I'll highlight the effort there. During the past quarter, we added, I believe, in the ballpark of 20-or-so HVAC companies as partners, so we're continuing to work to build kind of an early partner base. We've got a new flavor of the thermostat that's important to that channel coming out the second half of the year and some analytics as well that strengthen the offering there. So I would say at the moment, we're getting nice, early traction. You take a couple steps forward and you learn about a capability that's necessary to really get the offering down in for the channel. So we take a step back and we reengineered it to drive that capability. Here, we're creating a category that hasn't existed. So there's not some other offering out there that we can kind of take hints from or attempt to replicate. We're working directly with those in the field that service that market to really gather their requirements and perfect the offering as we go. So haven't taken off to the point that it's material contributor yet to the business, but continues to be a channel, particularly given the TAM dynamics there that we're enthusiastic about. And then we're also enthusiastic about it because of the synergies with what we do on the EnergyHub side of the business where we have found ways to monetize the connectivity that we deliver for purposes of gaining more transparency and also control of energy use in the residential sector. So continuing to work on it. No big updates this quarter.

And in my last question, I just wanted to ask about the hardware side of the business. Nice result this quarter, but if you look at guidance, it implies a lower result for the second half. Just wondering if any significant orders pushed from Q3 into Q2 or is it a result of the product updates with the Slim Line version or anything else that we should think about or is it just conservative on your part just given the visibility there less than the SaaS side of things.

No, I think we did see good sales of hardware in the quarter in Q2, and we did say that surpassed our expectations. Keep in mind, the summer months, our service providers partners tend to deploy a lot of hardware, a lot of new installations. And so it's very possible some of the cameras made have been pulled forward into Q2. So I think our guidance we provided for hardware for the year we're comfortable with, and I think it's right in line with what we're expecting at this point in time.

And our next question comes from the line of Brad Reback with Stifel.

Can you give us a sense if the Icontrol and the core alarm business on the subscription side are growing at the same rate?

Are they growing at the same rate? I don't actually have that data in front of me, but I would say that switches there are small things that are occurring all the time that kind of make it not particularly productive to attempt to segment them, meaning as an example, we have a couple of ADT dealers that have adopted Alarm.com. They were - would normally have used Connect, but I think, for whatever reason, they adopted Alarm.com. And whether we treat them as something that we inherited with the acquisition or whether we treat that as Alarm.com segment revenue, I think could be debated. Likewise, on the P1 side, we've seen P1 make a few changes to how they manage branches, which has driven some higher use of Connect. So I don't actually - I'm not sure I know the exact answer to that. But I would say as we look forward, there will be more and more places where some shift makes sense and it's logical, and therefore, we're going to focus on the overall SaaS number.

Great. And then just one follow-up. Just to try to avoid any potential confusion, was Icontrol about $8 million in the quarter?

So this is Steve Valenzuela. We didn't breakout Icontrol, but we did indicate that again if you look at that range, the $33 million to $37 million for Connect during the quarter, right? So when you say Icontrol, what we're talking about really is Connect. And so Connect we have indicated for 12 months following the acquisition about $33 million to $37 million. But again, that's not linear, right? So we haven't really broken that out. We haven't really intending to break that out.

And our next question comes from the line of Darren Aftahi with Roth Capital.

Just 2, if I may. You've mentioned the Customer Connections program in the PR. I'm just kind of curious if you could talk about any tangible benefit you're seeing, I guess, one with retention; and two, is there any kind of lift on any particular product service you'd call out.

Sure. I think we are seeing early indications that Customer Connections helps with both retention and upsell, so things that are easy, particularly for the consumer. There are 2 categories of things we may position to the customer via Customer Connections. One would be things they can add to the system themselves and others will be things that their service provider can come out and offer to them. So certain products like an indoor camera might be something that a consumer can add to their system, particularly if they already subscribed to video themselves. And other products like a well-installed outdoor camera would be something their service provider would come out and add to the system. And as people add to the system, they're investing in their security in the automation and the overall installation. And as the investment goes up, we think the retention characteristics also improve. So we think it's an important service that allows us to, in some way, do something that a lot of our smaller service providers wouldn't easily be able to do for themselves. And that is digitally maintain communication with their subscribers. And we think over a long period of time that it will help on both fronts, upsells and retention.

Great. And then, I guess, secondly, so you called out the last few quarters strength in video products, doorbell, outdoor, indoor. Just kind of curious, you guys have owned video objects. You mentioned analytics and a lot of the releases you guys put out. Just any strategic update there, and how it kind of fits to kind of the broader umbrella strategy of video going forward?

Yes. Good question. So in the first quarter, we announced that we had acquired ObjectVideo. And ObjectVideo's business was about video analytics. That's what they do. We added that team to our R&D team, and we have not yet put out functional upgrades specifically coming from that effort, but we are working feverishly with that team integrated with our video team to put out a set of analytic capabilities for both residential and commercial installations. But nothing tangible to report today.

And our next question comes from the line of Jack Vander Aarde with The Maxim Group.

This is Jack working with Nehal. Can you just - I know we talked about video penetration rates earlier, but I was wondering if you could give a sense of what percentage of the Alarm subscribers have a non-Alarm video-based hardware product. And then, I guess, from there, what percentage of those non-Alarm hardware subscribers are also integrating in Alarm video service that went into the platform?

Okay, Jack, this is Steve Trundle. It's hard for me to - since we don't have any real data I can rely upon on what our service providers may be finding in a home that's not Alarm.com product. We have pretty good data on, obviously, on the Alarm.com products that are connected, but I would only be hazarding a guess on frequency that they're encountering third-party video hardware. So I don't think I can actually answer that question. I would say we occasionally hear from a service provider that they go into a property and they already have some type of video product. And we have to actually explain to the customer why our product is superior and why integration with the rest of the home security apparatus and the home automation system makes sense and then replace that hardware. But I don't - I can't tell you with any degree of certainty how frequently that's occurring. So I apologize for that, but...

No, that's fair. Not the way I expected, but I just wanted to see if I could get a sense, but no worries there. That's it for my questions and congrats on a great quarter.

Okay. Thanks, Jack.

This concludes our question-and-answer session. We thank you for your participation in the Alarm.com second quarter 2017 earnings conference call. You may now disconnect. Everyone, have a great day.