Alarm.com Holdings, Inc. (ALRM) Q4 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Alarm.com’s Fourth Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Later, we will conduct the question-and-answer session and instructions will follow at that time. As a reminder, today's conference may be recorded. I’d now like to introduce your host for today's conference, Mr. David Trone, Vice President of Investor relations. Sir, please go ahead.

Thank you. Good afternoon, everyone, and welcome to Alarm.com’s fourth quarter 2018 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. Management’s discussion during the call today will include forward-looking statements, which include projected financial results or operating metrics, business strategies, anticipated future products and services, anticipated growth, investment and expansion; anticipated market demand for our current or future offerings or opportunities to expand into new markets; and other forward-looking statements. These forward-looking statements are based on our current expectations and beliefs and on information currently available to us. Statements containing words such as anticipate, believe, continue, estimate, expect, intend, may, will and other similar statements are intended to identify such forward-looking statements. These statements are subject to risks and uncertainties, including those contained in our updated Risk Factors section of our most recent quarterly report on Form 10-Q filed with the Securities and Exchange Commission and subsequent reports that we filed with the Securities and Exchange Commission from time-to-time that could cause actual results to differ materially from those contained in the forward-looking statements. Please note that these forward-looking statements made during this conference call speak only as of today’s date, and Alarm.com undertakes no obligation to update these statements to reflect subsequent events or circumstances, except to the extent required by law. Also during this call, management’s commentary will include non-GAAP financial measures and provide non-GAAP guidance. Management believes that use of these non-GAAP financial measures provides an additional tool for investors to use in understanding the Company’s performance and trends, but note that the presentation of non-GAAP financial information is not meant to be considered in isolation or as a substitute for the directly comparable financial measures prepared in accordance with GAAP. Reconciliations between GAAP and non-GAAP metrics for our reported results can be found in the financial statement tables of our earnings press release, which we have posted on our Investor Relations website at investors.alarm.com. This conference call is being webcast and is also available on our Investor Relations website. The webcast of this call will be archived, and a telephone replay will be available on our website. With these formalities out of the way, I’d now like to turn the call over to Steve Trundle. You may begin.

Thank you, David. Good afternoon and welcome to everyone. We are pleased to report that fourth quarter results were above our expectations. Our SaaS and license revenue in the fourth quarter was $77.8 million, up 19% over last year. Our adjusted EBITDA in the fourth quarter was $20.9 million. Our fourth quarter results helped close out a strong 2018. Throughout the year, our service providers continued to be very effective with our technology in their markets. We owe much of our success to that performance. We saw nice growth in our core residential and commercial security business, and in other markets as reported by our other segment businesses. We believe that our progress in 2018 successfully extended our leadership in the connected property space. Today, more than 8,000 service providers service our technology in more than 6.1 million properties globally, and more than 90 million connected devices and sensors are enabled in the solutions provided by our cloud services. With our growing scale in the connected property space, we plan to continue to accelerate our pace of innovation, strengthen our service providers advantages in the marketplace, and increase our participation in the Internet of Things secular trend. Before I go further, I want to thank our service provider partners, our ecosystem partners and our employees, who all contributed to our progress in 2018. On today's call, I want to spend more time on several key elements of our 2019 strategy. Those elements include driving growth through innovation in our core channels, increasing the differentiation and adoption of our video services, developing international markets, and building our vertical businesses. Product innovation is the cornerstone of Alarm.com strategy. Last year, we launched a number of new products and expanded the Alarm.com platform to enable our service providers to attack additional market opportunities. In April, we lunched Alarm.com for Business. This new service is engineered for the needs of small and medium-sized businesses. It offers commercial grade security, video surveillance, intelligent automation, sophisticated user management, multi-location awareness, and intelligent operational reporting. Importantly, it's all delivered through a single integrated solution. We see a good opportunity for our service providers to upgrade small and medium-sized businesses from traditional, locally managed systems to our always-on connected solution. As part of our Alarm.com for Business initiative, we also recently launched Smarter Access Control. This commercial grade solution securely manages access to facilities and fully integrates with our entire spectrum of commercial services. We complemented the release of this offering with a series of new commercial grade cameras that expand the applications for our video services. Successfully driving adoption of a significant new service line like Alarm.com for Business through a channel, requires a concerted sales, marketing and support efforts. In 2019, we plan to work to engage our partners on multiple levels in order to drive further adoption of our commercial services in the market. To support this goal, we recently expanded our partner education program. This training gives our service providers access to the required technical skills for installing and implementing our commercial solutions, and establishes a consistent training standard for our service providers. During the year, more than 900 service provider businesses participated in our commercial training program, and more than 1,500 technicians completed and passed the required training for deploying our Smarter Access Control solution. We plan to continue to work hard to develop our service provider base in this area in 2019. We also enhanced the direct hands-on support we provide to technicians and installers. With the launch of Alarm.com for Business, we saw an expected increase in overall support volume last year. At the same time, our customer satisfaction and quality assurance metrics exceeded our internal benchmark goals. Providing reliable, trustworthy service to our partners is a core tenet of our strategy. Over the long-term, it helps our service providers become more efficient with our technology and helps us retain our valued partners. As we roll into 2019, we will also be focused on the success of ADT’s new command-and-control smart home system. We worked in close partnership with ADT to develop this new offering. ADT recently launched the deployment of this new offering, and early indications are positive. As ADT transitions to this new system, we will also continue to support and improve the existing connect platform that supports the ADT Pulse offering, which is used by more than 2 million subscribers. Also key to our 2019 strategy is the expansion of our artificial intelligence platform to drive differentiation and adoption of our video services. In October, we launched our video analytics offering. This launch was a result of a multiyear effort to extend our leadership into the fields of artificial intelligence and computer vision. Our new AI architecture enables video cameras to distinguish between people, vehicles, and animals. It can also track an object’s direction of movement and duration of activity. We offer these advanced analytics capabilities as part of an accessible and various cost effective video solution. With our video analytics platform now deployed at scale, we plan to expand the analytics capability to our full range of cameras and continue to train the system to address additional high-value use cases, particularly for SMB applications. Furthering the development of our international business is also a key element of our 2019 strategy. As I mentioned on our call last quarter, we feel that we have the right base of ecosystem hardware partners and carriers in place to enable international service providers to deploy our solutions at scale. In early 2018, we reached a milestone of 100,000 active international subscriber accounts, and our international team continued to add new markets and partners throughout the year. I am very happy with the global service provider relationships we have been fortunate to cultivate. And in 2019, we plan to focus on building out our global team and making sure that we can do an outstanding job in supporting these partners. Europe is one of the stronger international markets and one where we continue to make good progress. In August, we announced a partnership with Aviva, a leading global insurance company. They are launching a smart home security and energy management offering to their customers in Ireland. Our partnership with Securitas also remains strong. They are now offering smart security services in the Netherlands, Belgium, Norway and Sweden. And Securitas Iceland is also successfully deploying our solution. We also see continued momentum in Turkey, Australia, and New Zealand, as well as in Latin America where we added key strategic partners in the second half of 2018. Claro Americas is a large telco in the region and we partnered with one of their subsidiaries, called NET. NET is one of the largest cable television providers in Latin America, and they are piloting a video based solution in Brazil. GTD, another large telco in Latin America will launch our services in Chile. And G4S, a well-respected global security company, has launched our services in Colombia and Guatemala. We have more work to do to together to make these promising partnerships successful in 2019, and beyond, but these early relationships give us additional confidence in the global opportunity for our business. Our vertical businesses are another key element of our 2019 strategy. We report these businesses in our other segment, and they include PointCentral, EnergyHub and Building 36. PointCentral offers an enterprise level smart home automation service for property managers of both short-term and long-term single-family and multifamily rental properties. The PointCentral market includes vacation rental properties, residential REITs, and other businesses requiring an unattended access and delivery solution. PointCentral has developed particular momentum in the residential REIT space. For example, in 2018, they a partnership to deploy solutions to invitation homes portfolio of 80,000 properties. In 2019, PointCentral will focus on executing rollouts to many of these properties already under an agreement, while continuing to build their pipeline of new enterprise customers. EnergyHub offers an enterprise software solution that manages distributed energy resources for utilities. Through its cloud platform, EnergyHub intelligently orchestrates a range of IoT devices to provide a rich set of grid management services. In 2018, EnergyHub announced new and expanded programs with leading utilities, including National Grid, Lincoln Electric System, Salt River Project, Seminole Electric Cooperative and Sawnee EMC. They also recently announced an expanded partnership with Arizona Public Service. EnergyHub's platform will manage grid-edge devices that include battery energy storage, smart solar inverters, water heaters and connected thermostats, and provide APS with critical bridge services, such as load shifting, renewables matching, voltage support, and peak demand reduction. Meanwhile, Building 36 continues to make strides developing the HVAC channel and building their product offering. They also play a key engineering role in our energy management technology and were instrumental in developing our HVAC safeguards capabilities. This machine learning capability monitors HVAC system and can alert service providers and homeowners to trouble conditions before they escalate into more expensive damage or complete system failures. Although each of these vertical businesses are in different stages, I'm pleased with their collective overall progress. With skilled teams in each business, we’ll continue to invest to develop these opportunities through 2019, and report further on their progress as the year unfolds. To summarize, I'm very pleased with our performance this quarter and throughout 2018. We also have a strong plan for 2019 that I am excited about leading. Thank you again to our service provider partners and the Alarm.com team for their hard work and to our investors for their trust in our business. And with that, let me turn things over to Steve Valenzuela. Steve?

Thank you, Steve, and good afternoon, everyone. I will start with the review of our fourth quarter and full-year 2018 financial results, and then provide guidance for 2019 before opening the call for questions. SaaS and license revenue in the fourth quarter grew 19% from the same quarter last year to $77.8 million. This includes Connect software license revenue of approximately $10.7 million for the fourth quarter compared to $9.6 million for Q4 2017. For the full-year of 2018, SaaS and license revenue grew 23% from 2017 to $291.1 million. I should note that 2017 represents a partial year for Connect software license revenue from the closing of our acquisition of the Connect’s business unit of Icontrol on March 8, 2017. Our SaaS and license revenue visibility remains high with a revenue renewal rate of 93% in the fourth quarter, at the midpoint of our historical range of 92% to 94%. Hardware and other revenue in the fourth quarter was $33.6 million, up 42% over Q4 2017. The increase in hardware revenue was primarily due to an increase in sales of our video cameras. We continue to see strong sales of our video cameras with about one in four installs going to our existing installed base of subscribers, and the remainder going to new subscribers. Total revenue of 111.4 million for the fourth quarter grew 25% from Q4 of 2017. For all of 2018, total revenue grew 24% to $420.5 million. SaaS and license gross margin for the fourth quarter was 85.1%, down slightly from Q4 of 2017 gross margin of 85.5%. Hardware gross margin was 18.8% for the fourth quarter compared to 21.9% for the same quarter last year, primarily due to product mix. Total gross margin was 65.1% for the fourth quarter compared to 68.6% for the same quarter last year, mainly due to the lower hardware margins. Turning to operating expenses. R&D expenses in the fourth quarter were $24.4 million compared to $18.9 million in the fourth quarter of 2017, as we continued scaling our planned investments in R&D to support the opportunities we see in our markets. We ended the fourth quarter with 500 employees in R&D, up from 447 employees in the same quarter last year. Total headcount increased to 884 employees compared to 784 employees at the end of Q4 2017. Sales and marketing expenses in the fourth quarter were $16.3 million or 14.7% of total revenue compared to $10.9 million or 12.2% of revenue in the same quarter last year. Marketing expenses will fluctuate from quarter-to-quarter, based on planned marketing events and as we make decisions that affect the timing of various marketing campaigns. Our G&A expenses in the fourth quarter were $17.8 million compared to $13.6 million in the year ago quarter. G&A expense in the fourth quarter includes a $3.3 million impairment provision on a promissory note we provided to one of our suppliers, who is implementing a financial restructuring. This $3.3 million charge is recorded as an expense against both our GAAP and non-GAAP financial results. G&A expense in the fourth quarter includes non-ordinary course litigation expense of $3.2 million compared to $2.3 million for Q4 2017. Non-ordinary course litigation expenses are part of our adjusted measures and are excluded from our measurement of our non-GAAP financial performance. Non-GAAP adjusted EBITDA in the fourth quarter was $20.9 million, which includes the previously mentioned $3.3 million impairment charge of the note to our supplier. For 2018, adjusted EBITDA was $93.1 million, up 30% from 2017. In the fourth quarter, GAAP net income was $7.9 million compared to GAAP net income of $320,000 in Q4 2017. Non-GAAP adjusted net income increased to $14.5 million in the fourth quarter compared to $13 million for the fourth quarter of 2017. Non-GAAP net income for 2018 was $66.1 million or $1.33 per diluted share, up 47% from non-GAAP net income of $45.1 million or $0.92 per share for 2017. Turning to our balance sheet. We ended the fourth quarter with $146.1 million of cash and cash equivalents. Note, in Q1 2019, we paid $5 million of the TCPA legal settlement and expect to pay the remaining $23 million later this year. In the fourth quarter, we generated approximately $25.7 million in cash flow from operations, compared to $18.6 million for the fourth quarter of 2017. Our free cash flow for the fourth quarter was $24 million, up from $15.8 million free cash flow for the same quarter last year. Through the 12 months ended December 31, 2018, we generated $49.7 million of free cash flow compared to $46.7 million for the same period in 2017. Turning to our financial outlook. For the first quarter of 2019, we expect SaaS and license revenue of $78.5 million to $78.8 million. For the full-year of 2019, we expect SaaS and license revenue to be between $328 million to $332 million. We are projecting total revenue for 2019 of $440 million to $450 million, which includes estimated hardware and other revenue of $112 million to $118 million. We estimate that non-GAAP adjusted EBITDA for 2019 will be between $101 million to $103 million. Non-GAAP net income for 2018 is projected to be $69 million to $71 million or $1.37 to $1.41 per diluted share. We expect our non-GAAP tax rate to remain at 21% for 2019. EPS is based on an estimate of 50.4 million weighted average diluted shares outstanding. We expect full year 2019, stock-based compensation expense of $17 million to 50.418 million. In summary, we are pleased with our performance in the fourth quarter and full-year 2018. We are focused on executing on our business strategy and investing in our growth opportunities, while continuing to deliver solid financial results. Thank you for joining us on our call today. And with that operator, please open the call for Q&A.

Our first question comes from the line of Nikolay Beliov with Bank of America. Your line is now open.

My first question is for Steve Trundle. Steve, can you talk about the product and technological differences between ADT Pulse and ADT Command, and what’s the likelihood that ADT might become keen on moving the Pulse subscribers to ADT Command?

The ADT team designed a new -- entirely new application, which is being called Control. The architecture is more of a SaaS architecture than an on-premises architecture. There are a number of new feature sets. They established a new hardware platform for the offering as well. And, I’ve got to be careful and that it's in their offering and I want to let them talk about it. But, it's just -- it's a significant upgrade over what they have been offering. And that's not to say that with Pulse we want -- continue to make a number of upgrades and continue to enhance that platform as well.

Then, a question for Steve Valenzuela. Steve, when you look at the subscription revenue guidance for 2019, and at high level, what is underlying assumptions you have embedded into the guide. It looks a little bit lighter than we expect that?

So, consistent with our past practice, when we're giving a guidance range, we’re considering what we have, what we know today. And so, we don't factor in additional upside or we don't factor in a lot of the growth initiatives that we know are out there that are still early stages. So, we’ve just consistently provided guidance based on that methodology. We think that's worked well for us and we've really stuck with that.

Our question comes from the line of Adam Tindle with Raymond James. Your line is now open.

I just wanted to start about Steve Trundle, you've talked about being very thoughtful about the investments that the Company makes. In the past, you’ve talked about every dollar of marketing typically brings about dollar or more of incremental SaaS revenue. But I know you have a number of initiatives and vertical market expansion that you outlined. So, I'm just hoping that you can touch on how do the payback rules of thumb change because kind of to the point of last question, it seems like a step function decline in payback and SaaS growth rate based on 2019 guidance versus what you would expect to pay back, it's still less than 1. I acknowledge that you outperformed initially in 2018, but hoping you can touch on those dynamics?

Sure, yes. First, keep in mind that ‘18 had a partial benefit from the Icontrol acquisition. But looking at those other segments, the payback is just a lot longer and then more material. So, there's certain investments we can make where we’re looking inside of the year and we can see sort of instantaneous results -- not instantaneous, but you can see certain customer creation activity result from certain sales activity. And then, with the other segment businesses, these are more R&D investments at some levels, where as our experience with the Alarm.com is an indicator, we're looking out over a 10-year horizon and thinking about where we want to be in half a decade and then a decade, and which markets we want to be in. So, it's much harder to sort of do an NPV calculation on the investments we’re making there. But, we think that the upside merits, more speculative investment and likewise. We think that the strength of the Company has enhanced with adding sort of increasing breadth of markets that we’re able to serve and enable. So that's sort of how we look at. I think we're probably a little less focused on spreadsheet mechanics when we think about our other segment businesses and sort of the long-term goals that we have there.

I would say that the other segment is growing faster than overall Alarm.com. And If you look at in 2018, the other segment, which includes EnergyHub, PointCentral and Building 36, contributed 8% of total revenue, that's up a 100 basis points from 2017, when they contributed 7% of total revenue. So, while they’re still early stage, they are contributing more revenue and becoming more significant to overall Alarm.com total revenue.

Maybe just a quick follow-up. I wanted to touch on kind of more near-term differentiated results. We've seen significant weakness from the publicly traded DIY players, like in the security camera market, even the pro-install players at the high-end and the CEDIA channel have experiences slowness. So, I'm just hoping that you can maybe reflect on the different channels around you, and how you’ve been able to navigate with strong double-digit growth while they’ve seen turbulence?

Yes. It's a good question, Adam. We are not in those markets that much. So, we don't see sort of a day-to-day pressures in activities that exist there. We have noted some of the results that have come in. I think, what we've been sort of stating fairly consistently is it really isn’t all one market. There is a market that prefers what we characterize as real security, robust security where the homeowner views the implementation of the smart home system and particularly the smart security system to be an investment in their property. And therefore, it's important for them to have a trusted relationship with a special service provider, and that market has been robust. And so, I think we've been probably less exposed to some of the volatility. If you think about the DIY markets, they tend to be affected by where you are in the early adopter versus mainstream sort of adoption curve. And you never really know where you are on that curve at any given point in time. So, it's easy to extrapolate that you are already in the mainstream and you are sort of kicking along at a certain rate and then you really realize you're sort of at the tail end of an early adopter stage and you've got, you don't -- it's much harder to predict those businesses I think. So, fortunately, our business is proven and it's been around for a while and we have a lot of confidence in our service providers. If I think about the high end, I think probably the reason we've -- maybe not seeing some of the same indications there as what we've heard there are first where slightly we’re less exposed to new construction starts and second, I think that the buyer is still -- at least our buyer, our buyer is a security first customer. And people always have a need for security and safety and through thick and thin. So, I think, again, we've been able to maybe not see as much volatility there as some of the others.

Our next question comes from the line of John DiFucci with Jefferies. Your line is now open.

Hi. This is Julian Serafini on for John. So, I guess, I just want to touch back on the guidance again. I know, you've touched on earlier, and Steve, you talked about not factoring in all the upside necessarily. I guess, I just want to confirm that, the core business is still going strong and going well, because even if you factor in some upside, there is still a bit of decel from 2017, 2018. So, I just want to confirm that, things are going well in the core business at least?

Yes. We’re still very busy. I think, we've seen sort of mid-teens growth coming. We provided initial outlook last year. And actually, I think on the total side, we’ve raised that number with this outlook. So, business is still doing well, we’re growing nicely on a percentage basis, we’re not growing it quite the way we were when we were a smaller company but we’re still improving the outlook about the growth we see and the outlook for the year and then about a lot of the upside you are seeing, some of the emerging opportunities. So, generally, our billings are pretty positive right now.

And then, just the second question is on the video product. I think, you talked about, driving some of the video products and video analytics going forward this year. Are you going to do anything in terms of like incentivizing subscribers, maybe discounts in the video hardware or something to like incentivize, you want to upgrade to video products?

That’s a really -- that's a good question. And I’m chuckling because it's question that reflects a conversation we've been having in the last week, which is exactly what is the upgrade cycle on video cameras and what if a customer has video cameras that are 3, 4 years old, is there a sufficient sort of gain and the capability that we really should do more to drive adoption. We're already seeing, Steve V said moment ago where he’s seeing one out of four of the new cameras going into existing customer account. So, my belief is the functionality is still materially -- so much better with the new cameras and with the analytics capability that we probably don’t have a need to do just for the purpose of video to do any sort of inducement to purchase. But, I think that there may be reasons to package up the new video analytics capability with something like an LTE upgrade offer and use it to generate pull-through for some other types of goals we may have in the Company.

Our next question comes from the line of Kevin McVeigh with Credit Suisse. Your line is now open.

Great, thanks. Hey. You spoke a little bit about the commercial initiatives. I wonder if you could give us just an update on that, any thoughts as you kind of roll that out, maybe more so in ‘19. And specifically, as you think about the dealer network, is it an expanded dealer network given it's a bit of a different skillset from an installation perspective, or do you still focus on the core dealers in the residential that offer both type of services?

It's both actually. So, the existing base of service providers, quite a few of them have serviced commercial in one frame or another, in one way or another historically, and some have not. But in any case, all of them have one thing in common, which is hopefully they have a trusted relationship with Alarm.com, and they therefore will be open to levering our capabilities on the commercial side or developing a commercial business around our capabilities, so that's what I'd say about the existing partners. There are a set of players in the industry that are purely commercial that really aren't residential, and now, we have a reason to have a dialogue with those parties, so we anticipate some expansion of the partner base. I think we even saw that a bit toward the end of last year where we're in discussions and going through the process with service providers that focus really on the SMB segment where we've designed this offering to focus. And it's still fairly early, but we did see meaningful uptake last year of the commercial service plans and made a lot of progress I think also in getting the access control component of that commercial plan embedded in the market.

And then, should the traditional relationship between the SaaS and the hardware lines across the revenue stay constant as you get more commercial, or should we expect that to flex up or down a little bit?

That one's a bit of a hard one for us to predict because it's a little bit partner-dependent or ecosystem-dependent, and at various points, we will engage with the other parties that are in the ecosystem in different ways. Sometimes we'll make a product; sometimes we'll introduce a new partner. So, the long-term trend there is challenging for us to really predict. What I will say is in the near-term, obviously, with the commercial plans, we're creating more value. There's a wider range of services, and therefore, the arc through there is a bit higher. At the same time, those customers tend to not be satisfied with one camera but instead need several, and there's a more meaningful hardware component as well as they build out a full solution. So, I don't know that I have an exact prediction for you, but I would probably say something in line with historical numbers is probably the right place to be right now.

Great. And then just one last one if I could. With ADT's partnership with Amazon, have you started to see any impact on that in terms of flow-through to your business from ADT, or are we still too early in that process?

We're still too early in that process.

Our next question comes from the line of Matt Pfau with William Blair. Your line is now open.

I wanted to get a little bit more detail on the video analytics product. And so, in terms of initial uptake of video analytics, has that primarily been from new customers or have you seen uptake from existing customers? And then [inaudible], I believe that's only available on two of the cameras that you deploy, so as you make that more broadly available, maybe you could give us an idea in terms of maybe percentage of your base of video customers that would potentially be able to adopt the product as you implement it into more video cameras?

I'd say we've seen the adoption on both existing subscribers who have video cameras that have the processing power required to support our analytics offering. There were a number of folks that were waiting. And then we're definitely seeing the adoption on new installations because they're using a mix of cameras that are more likely to support the capabilities. You're absolutely correct though that at the moment in the camera portfolio, there are a handful of our cameras, especially the POE cameras that are not yet generally available in a way that supports analytics capabilities. So, I think as the full portfolio supports the video analytics' ability, we'll continue to see a rise in the adoption rate there, but it's already at a rate that I can almost envision over the next few years that some base level of functionality will become standard table fare that's sold into every installation.

And then, have you been working with your partners to educate them more on the offering and get them to push it through to customers, or is there more of an opportunity there from a marketing perspective with your dealers?

I definitely think there's more of an opportunity there to educate the service providers and also the consumer, and there is always a bit of a lag. People hear about it, but until they have actually done a few installations, watch what happens to their customer service intensity, get comfortable that the customers are happy, it just takes a while. It takes a while for us to train, and we're still in a pretty early part of that cycle, so we definitely have an opportunity to do more there.

Our next question comes from the line of Gabriela Borges with Goldman Sachs. Your line is now open.

Good afternoon. Thank you for taking my question. Steve Trundle, I wanted to follow up on some of the earlier comments. I understand that you're limited on what you can say about ADT, so I'll focus instead on the implications for your business model. How should we think about the RPU and gross margin on some of the new SaaS-like architecture product versus the classic SaaS business? Thank you.

Gabriela, you're comparing our tradition SaaS business to which product?

The new ADT interact -- the new ADT SaaS-like stack.

Oh, I see. I see, okay. The new model is more like our traditional Alarm.com model in that we're trying to deliver a fuller range of services that include all the operations of hosting the offering or redundantly hosting the offering, managing a set of carrier and communication relationships, and doing as much as we can to provide the maximum amount of efficiency and leverage from our abilities as we can. So, it's more like the traditional Alarm.com business model.

That's very helpful. Thank you. And the follow-up is a high-level question on the earlier comment on early adopters versus maybe interactive technology becoming a little more mainstream. So, maybe for Steve Trundle, I would love to get your thoughts, where do you think we are in terms of adoption on the transition from classic, traditional security to something more interactive like what Alarm.com offers? Thank you.

I was almost speaking about the adoption curve. Someone had asked me about the DIY products and trying to know where you are, why are we seeing the turbulence there, and I was sort of speculating that we just don't know where they are on the curve. In our case, I think we do know a little bit more about where we are on the curve just because we've been at it for a decade, and I think we're into the mainstream and have been into the mainstream for the last couple of years and are gradually executing the process of moving, hopefully, the entire market from one that was dominated by a POTS-based not-always-connected solution to one that is always connected. I guess rough math would be that there're somewhere between 20 million and 25 million of those historic customers, and we're probably 8 million or 9 million into that base at this point with interactive capabilities, and then of course we're working to increase the size of that market as well. So, it all depends on how you define the market, but I think in the space that we serve, which is really the professionally serviced customer on the residential side, we're in sort of the mainstream component of the curve. On commercial, we're probably still in the early adopter part of the curve at the moment.

Our next question comes from the line of Jeff Kessler with Imperial Capital. Your line is now open.

Thank you and thank you for taking my call. First question would be on the introduction of Smart Signal and what you're going to do with it. Can you give us some type of timeline with regard to, number one, how are you going to train and get Smart Signal out into the marketplace because it seems like Smart Signal is the first part of a maybe ASAP to PSAP type of jump start, but it's also obviously a lot more of a personal item to be able to actually make things convenient for the end use. So, the first question is around Smart Signal and what you're going to do to get greater adoption and how you're going do it.

Good question, Jeff. So, we're excited with the award we were able to get on that capability at CES. The whole goal here is to give the user control and at the same time, in this case, to really cut back on the false dispatches and false alarms that central stations, unfortunately, and first responders have to deal with. So, with Smart Signal, we're giving the customer a lot of control in terms of their ability to cancel out alarms and do that from their mobile app and the process there. And then of course the second thing is also very important, which is we're giving the customer the ability to initiate a panic from their mobile device and route that into both the control panel and into the central station, and ultimately, to the PSAP. So, in both cases, the way it works is the app, the functionality is actually built into the platform and it's now available essentially to any subscriber with one caveat. Their service provider and then the underlying central station has to be comfortable with the functionality and be ready to turn it on because the way the signals come in, there are new types of signals that they may not have previously needed to deal with. There are new types of response regimens that they need to train their operators on. So, what we're seeing is everyone's enthusiastic about it. The initial service providers that have deployed are confirming that we're seeing a reduction in the number of signals hitting the central that require the operator to make calls, and we're also seeing a reduction in the number of false dispatches, but each central and each service provider will have to go through our training program and really test the functionality, then train their folks on how to handle these signals so that there's no deviation from protocol. So, that's what we're doing right now. Longer term, you're correct, it's part of an overall goal we have to make more efficient the way that with the wealth of information, the wealth of content that we have about a location and about what typically happens at that location, to provide better content and better information to the first responder so that everyone in the entire value chain is able to work most efficiently, so it's part of that cycle.

As a follow-up to that, as you know in December, a federal court upheld an ordinance from a small community in Georgia against the local alarm companies. And while it is a good, probably deserved, kick in the butt for some of these alarm companies who have been cruising on this for a while, it brings up, I would say, the need for an accelerated verification capability on the part of the leading companies in the industry who want to avoid the problems of these ordinances. And the question to you is beyond Smart Signal, what are you doing or what can you do to essentially become more of a verifier and obviously increase the value proposition for Alarm.com? I mean, I'm seeing beyond the integrated companies, it is also some of the independent monitoring companies that are monitoring the DIY guys are beginning to incorporate some of your stuff along with some other people's verification stuff because they realize that this is not something that is going to be for four or five years from now. This is something they've got to do in the next year or two.

So, two thoughts on that. I think that's a good point. I think that's probably a constructive trend for us in that folks do want to make sure that what they're passing to the first responders is a valid alarm signal, so what can we do about it and how does that help Alarm.com? First, for a long time, we've used machine-learning to differentiate between routine activity and unexpected activity, so we're at a point where you can imagine with the data we have on a property, and if you take the algorithms we're using, for example, in healthcare, we can predict the likelihood that a signal is false or real and provide one more data point there. The second relates directly to the video analytics that I've already spoken to which we can tell a lot about what's actually happening on a property, give people a first view of that, and I think we'll see our service providers move to increasingly lay on verification layers to increase the value of what they're providing to the first responders.

Thank you. One final question. What can you do to integrate and become part of the ecosystem of some of those companies that have been involved in both access control and video for mid-size and larger commercial companies but are trying to come down into the marketplace now? And come down meaning into the smaller commercial area. It could be competition for you, but they could also be partners with you as well. I mean, the names are well known in the security industry, and it seems to me that you have the opportunity here to not just integrate with smaller camera folks and smaller access-control folks but with people who have some larger systems out there to get your applications into a just slightly higher level of the small business and commercial area.

Good question, again. So, definitely, we're starting with a SMB focus. I think you have to focus and you have to train in one area. That said, the platform is not limited by the square footage of the facility in any certain way, and we're seeing a few installs that are 100 access point plus that demonstrate an ability of the platform to scale up, but if we think about our base of service providers, we think that initially, the sweet spot for them is in the SMB, and then we'll move from hopefully what we will build as a position of strength, we'll begin to move up market after that.

And I'm sorry, one last question and I will make it quick. You've got four or five businesses in the other category, you've gone from 7% of your total revenues to 8% of your total revenues. Can you talk about which of those businesses are actually seeing the greatest traction right now?

At the moment, the greatest traction is from EnergyHub and PointCentral.

Our next question comes from the line of David Gearhart with First Analysis. Your line is now open.

So, my first question has to do with the homebuilder channel. You recently announced the relationship with DR Horton, and earlier in 2018 in June, you announced a revised program and you had a relationship already with a large builder, I believe Toll Brothers. Just wondering if you could talk about adoption since that revised homebuilder program in 2018 and how we should think about attach rates for recurring service on new builds. Is there a percentage that you're seeing that we could use as a proxy to kind of handicap DR Home -- DR Horton builds and try to get a sense of how that could shape?

I'd say that roughly, so assuming you have a relationship with the homebuilder and you have the opportunity to speak to the customer, that the range of the take rate or the acceptance rate is between 40% and 50% is what you're generally seeking to obtain there. And it may be you have a higher percentage that are using more of an automation-only type of offering, but when we get to security, that's the take rate that we'd like to be seeing as a minimum.

And then in terms of ADT, you're supporting their new platform and their prior platform. The company recently announced earlier this month that it actually acquired a do-it-yourself solution, so I just wondered if you could provide some color, how you're thinking about DIY in terms of their having a solution? Is it something that Alarm.com can support, or is it just something that's too early to kind of discuss in terms of where you could fit in with that offering with ADT?

Yes. I guess, what I'd say, David, is it's probably a little early for us to discuss much there. I think we've seen for a long time, if I roll the clock back a year or two, there was a DIY partnership there with Samsung. I think it's not really a new dynamic that ADT is growing their business in a number of different dimensions. Our role today has been more on the professional services side, so we haven't really focused much on the DIY component. It's probably a little early for me to comment any further on that one.

And then lastly, litigation obviously picked up in '18 versus '17. How should we think about the direction of litigation expenses in '19? Should it be flat, up, down? Just for modeling purposes. Thank you.

Hey, David. It's Steve Valenzuela. I would look at it at about the same level as 2018, not including the $28 million TCPA settlement. So, if you take that out of litigation, litigation expense was around $17.5 million or so in 2018 compared to about $7 million in 2017. So, I would model right around the same level. And I have to say, litigation is hard to predict but I would use about the same level as 2018, not including the $28 million TCPA settlement.

Our next question comes from the line of Darren Aftahi with ROTH Capital Partners. Your line is now open.

I just want to follow up on the homebuilder question and kind of two parts to it. First, of the other major homebuilders you kind of haven't maybe publicly said you were working with. Is there any pushback to working with you or just kind of a function of time? And I'm kind of curious if there's more of a broader strategy with some of the commercial property side folks that build on that side in terms of breaking into your SMB as part of a long-term strategy. And I think last year, you guys disclosed your ending sub number for 2017, and I'm curious what that was for 2018.

Sure. I'll start with the last question. In my prepared remarks, I commented that we had entered the year with more than 6.1 million subscribers, and that's not inclusive of any subscribers that are IP license only. And then back to the former question on the builder business, there are a lot of builders that are big-name builders. There happen to also be a lot of local builders, and there's a lot of activity there that it wouldn't really rise to the top of being press-release worthy but is happening every day. I don't think yet there's a standard. I think builders are still experimenting with what their strategy should be, and some are beginning to move. I think one indicator of a mover is DR Horton where they've probably moved and been maybe a little more visionary, but I think there's not yet an answer. If I'm a builder, it's not yet known or the market hasn't said, this is what you do if you are a builder. They're still sort of trying to figure out what they should be doing around smart home, experimenting with a lot of things, and therefore, the sales cycles can be drawn out as opposed to, say, in other markets where folks know they need to do something, and we're simply trying to win versus one of our competitors. Your question on commercial and can we parlay that offering into a builder oriented program, to answer your question, we have not gotten that far. We're not doing that today, but one can envision if we have strength, for example with REETs on the resi side that perhaps we could build strength with the REETs on the commercial side and try to do more there, but we're not doing that today.

Our next question comes from the line of Mike Latimore with Northland Capital Markets. Your line is now open.

Hi, guys. This is Pavan [ph] on for Mike Latimore. I have two questions. Like, how many distributors are now selling your commercial offering?

So, the question is how many distributors are currently selling our commercial offering?

Yes.

So, we have a total of service provider partners of 8,000 plus that we've announced. We've typically added about a thousand service providers per year. If you look at a number of those service providers that are coming up going through our training program, we haven't actually disclosed a number. It's still a relatively small number relative to the overall 8,000, but basically, each quarter, we're going through a training program. We're training the service providers and their technicians on a regular basis. We haven't really disclosed that number though.

I don't know if we know the exact number. I think maybe the color that I gave in my prepared remarks was on the access side. We had trained 1,500 technicians, and then I think on the broader commercial line, I stated a number of individual companies we've trained, to that would be a pretty good indicator. Roughly right now, the commercial is still a small part of our base, but around 3% of the base in terms of those who are paying for commercial subscription plans.

And could commercial revenue surplus 10% of gross revenues this year? Can we expect that?

So, 10% of revenue, certainly the opportunity is there for the future. I wouldn't say that that would be a realistic goal for this year. Certainly, the potential is for commercial to contribute given that it's their early stage. Keep in mind, we just launched Alarm.com for Business a little bit, actually, less than a year ago and smarter access control. While we're seeing good performance there, it's still off of a small base. The longer-term opportunity clearly is quite significant given that there's over 4 million properties just in North America that we think actually are a valid tempera for us for commercial. But as Steve said, today, about 3% of our subscribers are commercial-paying businesses. Now, the RPU there is about two times that of the residential, two to three times, so there is a higher amount of RPU from commercial, but I would say a 10% number would be an aggressive percent of revenue for 2019.

Our next question is from the line of Jack Vander Aarde with Maxim Group. Your line is now open.

Steve Trundle, so, given earlier commentary regarding Connect platform enhancements and the new ADT offering. Do these enhancements to the Connect platform create potential for new or multiple pricing tiers within the existing Connect business model?

So, the existing Connect model, it's SaaS-like, but just to be clear, it is an on-premise deployment of the Connect software, and the new offering is more like the traditional Alarm.com-hosted SaaS offering. If I speak about Connect, on that, I think we're going to take direction from our customer on what capabilities they feel are most important for their base of more than 2 million subscribers on Pulse and really let the customer drive the way they want to implement pricing tiers, so I probably don't have an answer for you there.

Can you answer if the new enhancements to the Connect platform result in higher operating costs to you guys as Alarm?

So, the new offering is just, for clarity, it's not a Connect-based offering. It's a different software offering. And the new offering, it will have, for us, higher operating costs because we're rendering the full stack of services with that offering. Yes.

That's helpful. And then do you plan to continue to break out this Connect versus core Alarm SaaS profile going forward?

So, we've broken it out for 2018. We haven't decided whether or not we're going to be breaking out going forward, honestly, at this point in time. We provided that in the past. It may not be as relevant breakout for the future given the change to the new Command platform, but we'll update you on the first quarter conference call.

And if I could just ask one more, is there any change, given that hardware GM was flat Q-for-Q but down year-over-year, strong video sales again. Is there a change in the margin profile or the cost structure of the new video hardware versus last year's models of hardware that were sold?

Probably a bit of a change. It's mainly mix driven. It's what are the higher volume products that are being sold. And then I think someone earlier asked a question about analytics and are we anxious to get analytics more broadly deployed. The answer there would be yes. So, you can imagine if you're in our shoes, we want to do as much as we can to lower the impedance of getting that capability in the market. And as I've said before, our goal is to help our service providers create new customers. The customer lifetime value we think is very high, so there will be times where we're not that worried about the hardware margins if we think we're going in the right direction in terms of creating customer lifetime value.

And that concludes today's question-and-answer session. Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. And you may now disconnect. Everyone, have a great day.