Thank you for standing by, and welcome to the Alarm.com Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] As a reminder, today's program is being recorded. And now, I'd like to introduce your host for today's program, Matthew Zartman, Vice President, Investor Relations. Please go ahead, sir.

Good afternoon, everyone, and welcome to Alarm.com's Third Quarter 2022 Earnings Conference Call. Please note that this call is being recorded. Joining us today from Alarm.com are Steve Trundle, our President and CEO; and Steve Valenzuela, our CFO. Before we begin, a quick reminder. Management’s discussion during today's call will include forward-looking statements, which include, among others, projected financial performance and key assumptions related thereto, including with respect to the Vivint dispute, potential legal spend and cost rationalization strategies; the impact of emerging market dynamics, trends and anticipated market demand; the impact of the COVID pandemic, challenging global supply chain dynamics and adverse macroeconomic conditions; our business strategies, plans and objectives; and integration of recent acquisitions and anticipated growth prospects of our Noonlight acquisition; continued enhancements to our platform and offerings; opportunities for growth and expansion in our current and new markets. These forward-looking statements are based on our current expectations and beliefs and on information currently available to us. These statements are subject to risks and uncertainties, including those contained in today's earnings press release and in the Risk Factors section of our most recent quarterly report on Form 10-Q filed with the Securities and Exchange Commission on August 9, 2022 and in subsequent reports that we file with the SEC from time to time, including our quarterly report on Form 10-Q for the quarter ended September 30, 2022 that we intend to file with the SEC shortly after this call, that could cause actual results to differ materially from those contained in the forward-looking statements. Please note, that the forward-looking statements made during this 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 the use of these non-GAAP financial measures provides an additional tool for investors to use in understanding the company's performance and trends. However, 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 to 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 replay will be available on our website. Let's now turn the call over to Steve Trundle. You may begin.

Thank you, Matt. Good afternoon, and welcome to everyone. We are pleased to report another quarter of solid results. Our SaaS and license revenue in the third quarter was $133.1 million, up 12.8% over the same period last year. Our adjusted EBITDA in the third quarter was $40.8 million. I want to thank our service provider partners and the Alarm.com team for their continued strong performance. In my comments today, I'll update you on several new platform capabilities that expand our addressable market and talk a bit about our recent Noonlight acquisition. I'll also spend some time addressing the matter related to our patent license agreement with Vivint and close with some of the thinking that has gone into our initial look numbers for 2023. This quarter, we expanded the market for our Alarm.com for Business Video Solution with the introduction of third-party camera support. We estimate that our Commercial Video Solution will now work with about 80% to 90% of third-party cameras that have been installed in midsized and large commercial settings, since 2018. Supporting third-party cameras will make it easier for businesses to adopt, our integrated solution without the cost of replacing all the existing installed video cameras. We can also leverage a wider diversity of commercial camera form factors and capabilities to expand the fit for our video solution. For example, we can now address the needs of businesses with specific requirements for pinhole, fisheye, thermal and other camera types. To deploy this new capability the Alarm.com video team leveraged technology created and widely deployed by our OpenEye team for enterprise commercial customers. It's a good portrayal of the ongoing synergies that our 2019 acquisition, is producing. We also expanded the applications of our video solution with the introduction of Escalated Events. This software capability enables our…

Thanks, Steve. I'll begin with a review of our third quarter 2022 financial results and then provide our guidance before opening the call for questions. SaaS and license revenue in the third quarter grew 12.8% from the same quarter last year to $133.1 million. This includes Connect software license revenue of approximately $6.5 million for the third quarter down as expected from $7.9 million in the year ago quarter. Our SaaS and license revenue visibility remains high with a revenue renewal rate of 94% in the third quarter. Hardware and other revenue in the third quarter was $83 million up 11.8% over Q3 2021. Video camera sales continue to be the main contributor to growth in hardware revenue. Total revenue of $216.1 million for the third quarter grew 12.4% year-over-year. SaaS and license gross margin for the third quarter was 86.2% up about 100 basis points over the same quarter last year due to some modest scale benefits. Hardware gross margin was 19.1% for the third quarter, an improvement from 17.7% last quarter and up from 15.2% during the same quarter last year as we started to see some modest relief in shipping costs and our price increases took effect. However, this is still below our historical gross margins of 20% to 22% as the global supply chain continues to be challenging. We expect hardware gross margins for the fourth quarter to be in the range of 18% to 19%. Total gross margin was 60.4% for the third quarter, up from 58.2% in Q3 2021, due to the improved SaaS and license and hardware margins. Turning to operating expenses. R&D expenses in the third quarter were $55.6 million, compared to $44.1 million for the third quarter of 2021, mainly due to employee-related expenses. We ended the third quarter with 981…

[Operator Instructions] And our first question comes from the line of Brian Ruttenbur from Imperial Capital. Your question, please.

Thank you very much for taking my call. In terms of the Vivint, I'm sure you're going to be getting a lot of questions around that. But how long was the contract supposed to last? Was it perpetual and they just discriminately cut it off, or was there a certain period of time that it was going to end? And maybe you can walk us through the process?

Hey, Brian, this is Steve Trundle speaking. So I wish, I could walk you through the entire process. Unfortunately, the agreement itself is confidential the terms of the agreement are confidential. So that's why I spent some time in my prepared remarks kind of providing what insight, I could there, but we can't comment on the actual terms of the agreement unfortunately, so.

Okay. Maybe then as a follow-up I was on the ADD -- ADT call -- excuse me. And they said that your agreement is very much in place. Is there any other large agreements out there besides ADT and Vivint that is a very large percentage of your business, or is it a bunch of small little contracts?

No. Well, in terms of licenses there are other licensees. I would say that the revenue under licenses from Vivint was a high majority of license revenue probably in the 90% plus range. And as we articulated, I think when we discussed the ADT agreement that the license component of that actually kicks in as they transition to a Google-based platform at a later point in time.

Great. Thank you very much.

Yes.

Thank you. One moment for our next question. And our next question comes from the line of Saket Kalia from Barclays. Your question please.

Okay. Great. Hey, guys, thanks for taking my questions here. Steve Trundle maybe for you. Maybe just picking up on ADT, I was wondering if you could talk to how we're thinking about ADT impact next year to revenue. By the way thank you for providing that preliminary look to 2023. That's very helpful at this point in the year. I know that ADT is -- it's very early. The impact there is going to take a while. But maybe you and Steve Valenzuela can just help level set how we're thinking about that ADT impact at least in your preliminary 2023 guidance.

Sure. This is Steve Tunnel speaking. Yes, we -- I think, when we announced the revised agreement with ADT we anticipated at that time that ADT would create all professionally installed accounts on the Alarm.com platform through the end of 2022. We now believe that's going to be probably a longer period of time, and we almost have to look to ADT themselves for exactly what their internal plans are. But the relationship is very healthy. We're working together on a lot of different fronts. And I know when we put together our initial look numbers, we assumed that through at least the first quarter that professionally installed systems would be on the Alarm.com platform. And then we began to taper that expectation somewhat as we go into the second quarter. I think our best guess at this point is that we'll probably expect it to be more or less business as usual. And this is based at some level on ADT's communications. Again it's their plan but I think business as usual until the middle part of the year.

Sorry, go ahead, Steve Valenzuela

Saket we both indicated, we've factored in less hardware revenue for next year from ADT. They've not been a major contributor to hardware revenue, but we have factored that into our guide for 2023 for hardware revenue. It's a modest impact.

Yes. Got it. That's very helpful. Steve Valenzuela maybe for my follow-up for you. I know that there's some normal course litigation expense. There's some, of course, non-normal course litigation expense like Vivint. Can you just remind us that EBITDA -- the preliminary EBITDA guide for 2023, what's excluded from non-GAAP EBITDA, what's included? I think that EBITDA number is a little bit lower than what we were expecting even adjusted for Vivint. So I just wasn't sure. I wanted to make sure we were clear and kind on what was being excluded versus included?

Yes. It's most of that legal number that Steve Trundle threw out of $16 million to $20 million. Most of that is affecting adjusted EBITDA for next year because of the nature of that legal spend. So, it's not adjusted out of the adjusted EBITDA like some of our legal is. And it gets into technicality. We've assumed when we've put together the initial look for 2023, most of that legal spend would be hitting adjusted EBITDA. In other words, reducing our adjusted EBITDA and that's one of the reasons why the adjusted EBITDA guide is lower for 2023.

Just to bring that through. So we don't actually know at this point Saket, exactly what legal measures we may pursue. So we have to assume that those incremental costs would not be adjusted out at this juncture. And so you have that sort of expense that I mentioned in my prepared remarks. Steve just indicated the majority of that, at least at this point we're assuming would not be adjusted out. And then you have, of course, the actual top line $24 million component that, of course, no longer flows into adjusted EBITDA. And then the only other thing I think we've mentioned is that we did acquire Noonlight in the third quarter and are planning to invest into that business throughout 2023, because it's a high-growth business. So there's probably $5 million or $6 million of investment, we're making there that's a new investment as well. And those are all factored into the initial look that we provided you.

Got it, very clear. Thanks guys. I’ll go back in queue.

Thank you.

Thank you. One moment for our next question. And our next question comes from the line of Mark Cash from Raymond James. You question please.

Thank for the questions. This is Mark on for Adam. So, maybe just to kind of circle back to these last two and maybe ask in different way. With Vivint refusing to pay, I guess what could stop ADT from pursuing a similar strategy in 2023 and beyond? Is there anything you can talk about if it's broadly, different about the contractor relationship that makes the outcome less likely?

I would just -- I guess I would just say that our relationship with Vivint is a very positive relationship where we're --

ADT.

I'm sorry, with ADT. We're collaborating to service millions and millions of subscribers every day. So we're working together. It's much more of a win-win oriented type of relationship and you contrast that with Vivint, who filed a suit against us while we were on our roadshow during the IPO has been more or less just a little bit more of a problematic relationship and that's probably my overall view.

Okay. That's helpful. Thank you. And if I could ask a follow-up. I know you just acquired Noonlight. Balance sheet is very healthy and valuation is coming down. And maybe if you could just talk about the M&A philosophy and would you consider something larger to perhaps accelerate diversification to areas like international, commercial, and how do you weigh those different adjacencies? Thank you.

Yes, absolutely. So we continue – we did just finish this acquisition. We continue to look at various opportunities. The opportunities are becoming I'd say, increasingly more attractive to us now. We're seeing some rationalization on valuation. International as you just mentioned is in fact an area where we have some level of focus and have been looking at various opportunities that may help us accelerate what is already a pretty healthy expansion internationally but that is a domain that we are looking at. We continue to look at the energy domain, we continue to look at video domain and then we're always looking for attractive acqui-hire but usually much smaller opportunities.

Did that answer your question?

Yes, thank you so much.

Thank you. One moment for our next question. And our next question comes from the line of Dillon Heslin from ROTH. Your question please.

Hey, thanks for taking my question. Just to start, I'm wondering if you could comment a little bit more about commercial and the cadence of growth there. I think coming a little bit more out of the pandemic, earlier in this year, you mentioned, seeing better growth there. So I'm just curious what the cadence looks like there. And is that 80% to 90% camera adaptability if you want to call it like the main pain point you were seeing in terms of trying to get better penetration?

Yes. The cadence there is pretty good. As I mentioned last quarter, we're pretty focused on the – particularly the SMB, TAM, which we put at around 5.5 million potential subscribers in North America. The velocity that we have with the OpenEye business is strong. The business continues to grow its SaaS revenue at a nice pace. So generally, we're continuing to see good progress on the commercial and small business side. In terms of the specifics, camera support is a meaningful issue. OpenEye has done a great job through time of supporting a range of different third-party manufacturers with their cloud-based video solution. In the Alarm.com commercial part of the business which tends to service a smaller customer not as much an enterprise you can think of OpenEye at schools, institutions, hospitals large footprint, deployments. Oftentimes, Alarm.com typically with its commercial video is servicing a somewhat smaller footprint location. And even there though ripping out all the existing cameras, creates a real impediment to getting the software deployed. You have to sell through replacement for call it eight cameras on a restaurant to actually light that restaurant up with our commercial video solution. So being able to support a wider range of cameras, at least those that have been installed since 2018, we think will allow our service providers to be a little bit more nimble and effective in closing a wider range of opportunities that they see.

Great. And then as a follow-up, if I look quickly at the fiscal year 2023 preliminary projections and try to normalize for the Vivint impact, how do you think about that delta of growth coming from your core SaaS business versus the contribution from Noonlight?

Yes, you're already normalizing and probably seen that the number we put out is not -- is a little higher than what you would get if you simply deducted the amount that we are taking out for the Vivint matter. Yes, there's a contribution twofold there. First, the core business is performing a little stronger than we probably previously expected. So there's some contribution from that. And then there's a modest contribution, call it right around $5 million that we're expecting from Noonlight.

Got it. Is that $5 million the annual number or per quarter?

Yes, that is.

Thank you. I’ll turn back in the queue.

Sure.

Thank you. [Operator Instructions] Our next question comes from the line of Willow Miller from William Blair. Your question, please.

Hi all. This is Willow on for Matt Pfau. So given the current environment, how are you thinking about investments and expenses next quarter and next year? Are there any areas you're considering pulling back on especially if legal fees are higher than expected?

Yes, good question. I'll start with that. We will do some what I think I called modest cost rationalization across the business. So, there -- we like to produce cash and we like to produce as much cash as we can, so we are going to have some higher expenses on the litigation side and it would be probably be prudent to pull in some costs elsewhere, when we think we can do that without impacting one of our growth strategies. So, we've already done most of that work in our initial look. And as I said, there will be some modest either cost postponement in some cases or some cost cuts here and there. But we're not planning any wholesale dramatic reduction of costs. We think that the things we're investing in, in terms of growing the business internationally, growing the commercial business, really launching the Noonlight business further, all on a -- are all very rational places to invest, so that we're growing over the next decade. And we think that most of these higher costs in 2023 are temporal in nature. So, you would really hijack the company if you overreacted to those costs and then you come out of it and you don't have it anymore. So that's kind of how we're thinking about it.

Okay, great. Thanks.

Thank you. One moment for our next question. And our next question comes from the line of Jack Vander Aarde from Maxim Group. Your question, please.

Hi. This is Jack Codera calling up for Jack Vander Aarde. Thanks again for taking my question. Just a quick check on visit, I got the 2023 range. But I was wondering, is there any estimated 4Q 2022 impact legal expenses? And then, I have one more follow-up.

Yes, we do have factored in some legal expenses in our guidance for Q4 2022. We haven't really broken that out, but it is factored in our EBITDA guidance for the quarter. And of course, we factored in the $6 million less. So if you take the -- you could take the $6 million less from Vivint right, that comes right off the bottom-line, plus there's some factor in the legal expenses that we're not assuming are adjusted out of adjusted EBITDA as well. That's factored into our guidance. And then, of course, there's, some costs in there for Noonlight as we talked about, it has less than $1 million that impact on our EBITDA for Q4 to our guidance in Q4.

Yes. And then, actually, I missed just for the 2023, the preliminary, I missed the bottom range of the EBITDA, do you mine mention that again?

The 2023, the initial look for EBITDA, I just want to clarify, 2023, right?

Yes.

Okay. So look, we've reset a range of $110 million to $125 million adjusted EBITDA for 2023. So a wide range, because of the variability of the various matters that Steve talked about.

Yes. Thank you so much. And then, actually I have one last question, a little bit of a turn. I'm just wondering if you could share any color on the tax rate for video camera services and analytics on new camera installs? Thank you.

Yes, the video attachment rate continues to progress continues to do very well. The attachment rate in Q3 was over 50% for video and over 70% of those were video analytics. So we continue to see very good progress in video. And you could tell that as well with our hardware revenue, where hardware revenue is continuing to perform quite well, mainly driven by Camera sales.

That's amazing color. I'll jump back in queue. Thank you guys.

Thank you.

Thank you. This does conclude the question-and-answer session as well as today's program. Thank you, ladies and gentlemen, for your participation. You may now disconnect. Good day.