Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Alarm.com Q3 2019 Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions] I would now like to introduce host of today’s conference call Mr. David Trone, Vice President of Investor Relations. You may begin.

Thank you. Good afternoon everyone and welcome to Alarm.com’s Third Quarter 2019 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 performance for the fourth quarter and full year 2019 and for 2020, anticipated timing of payments of certain liabilities, the impact of certain investments in our business, our business strategies, continued enhancements to our platform, anticipated market demand for our offerings, opportunities for growth in our current markets or 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 file 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 the 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 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 telephone replay will also be available on our 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, David, and welcome to everyone joining our call today. We are pleased to report another solid quarter that exceeded our expectations. SaaS and license revenue in the third quarter grew to $84.9 million, up 14.3% year-over-year. Our non-GAAP adjusted EBITDA in the third quarter was $26.3 million. We've had an active quarter and early fall. We introduced a number of smart home solutions and devices. In September, we gathered the entire company together over the course of several days to review our long-term strategy, product roadmap, and progress against our goals and to better connect as a team. We also recently hosted a number of our service provider partners here in Washington DC for our Annual Partner Summit to present our latest products and R&D priorities. And in late October, we announced the acquisition of OpenEye, a leading provider of video management software for commercial applications. On today's call, I'll focus on the new smart home products we launched and the acquisition of OpenEye. I'll close by providing some initial thoughts on our planning process for 2020. Starting with our product pipeline, we launched two new residential video cameras that significantly upgrade our indoor and outdoor lineup. Both cameras, presents sleek industrial designs, offer increased field of view and provide enhanced picture quality even in highly variable lighting conditions. They also have substantially increased onboard compute capacity. This improves their overall performance and gives us an edge computing environment that we can use to support the more advanced video analytic capabilities that we plan to deploy in the future. A common challenge with deploying and supporting most video cameras or other IP devices is their dependence on the subscriber's Wi-Fi network. Our two new cameras have isotropic antennas that create a more uniform and efficient wireless connection. We also…

Thanks Steve. I will begin with a review of our third quarter 2019 financial results and then provide guidance for the fourth quarter and our raised outlook for the full year of 2019. Before opening the call for questions, SaaS and license revenue in the third quarter grew 14.3% from the same quarter last year to $84.9 million. This includes Connect software license revenue of approximately $10.8 million for the third quarter, compared to $10.5 million for Q3 2018. Our SaaS and license revenue renewal rate was 94% in the third quarter at the high end of our historical range of 92% to 94%. Hardware and other revenue in the third quarter was $43 million, up 14.4% over Q3 2018. The increase in hardware revenue was primarily due to an increase in sales over video cameras. Total revenue for the third quarter was $127.9 million, up 14.3% over the same quarter last year. SaaS and license gross margin for the third quarter was 85.4%, up approximately 90 basis points from the prior quarter, mainly due to improved efficiencies we have been able to achieve in our network operations centers. Hardware gross margin was 18.3% for the third quarter, compared to 18.8% for the same quarter last year, primarily due to product mix. Total gross margin was 62.8% for the third quarter, slightly better than gross margin for Q3 2018 of 62.5%. Turning to operating expenses, R&D expenses in the third quarter were $29.5 million, compared to $22.9 million in the third quarter of 2018. As we continued our planned investments in R&D to support the opportunities we see in our markets. We ended the third quarter with 582 employees in R&D, up from 496 employees in the same quarter last year. Total headcount increased to 1,043 employees compared to 866…

[Operator Instructions] Our first question comes from Adam Tindle with Raymond James.

Hey, good afternoon. This is Madison on for Adam and thanks for taking my question. I know you've been expanding your presence internationally in areas such as Brazil and Chile and also adding SaaS to existing markets. As this has expanded recently, I was hoping you could talk about how this has progressed relative to your expectations and any early learnings that you can share with us. Thanks.

Sure. Madison, this is Steve Trundle speaking. I would say that generally the progress we've made internationally has been in line with our expectations at this point. We've had a few positives and a few bumps here and there, but I think we're probably more excited about the way it's shaping up for the next 12 to 15 months than – at any period in the past it's growing, it's growing at a faster rate than the rest of the business. We're – I think closing the gap on small, on the set of – we're closing the gap on all the little things that you have to get right to really deploy at scale in the international market. So in general, we're pleased and feel like its tracking about where we expected it to begin the year.

Okay, thanks. That's helpful. And then just on hardware revenue, it looks like guidance implies a pretty meaningful decline on a sequential basis. I know there's a little bit of seasonality there, but it's obviously above what we've seen historically. Can you just talk to some of the drivers on the hardware revenue guidance? Anything outside of just typical kind of conservatism there would be helpful? Thanks.

Sure. This is Steve Valenzuela. Typically Q4 is seasonably the weakest quarter for hardware. If you look at past Q4 is typically the lowest hardware contribution in the quarter for the year. And that's typically tied to the holiday season and people focus on a number of other things. And so it's just typically seasonably a weaker quarter of the year for hardware.

Thank you. Our next question comes from Nikolay Beliov with Bank of America.

Hi, thanks for taking my questions. When you guys look at your business for the next 12 months, I know you're still doing the plan for 2020. And look at the incremental business, is there a way for you to start rank for us the major contributors by size to the incremental subscription revenues over the next 12 months. And I'm referring to maybe the new dealers you signed up, expansion with existing dealers, international, commercial, just go down the key revenue drivers. That will be helpful I think.

Sure. I don't know if I can give you an absolutely discreet breakdown by each of those domains, but I can give you some thoughts on how we think about it. And you got some of the first parts right. So we have the core North American business that's growing at a certain clip. One of the big drivers there really has been – really there are a couple of drivers that also play internationally. But especially in North America, the success we've had with the video offering. And then the recent addition of analytics to the package is helping. The commercial piece in North America growing a little bit faster even this year than the residential piece for us in terms of percentage growth and still is growing off a small base but is becoming increasingly relevant. So it will be a focus next year. And obviously, with the acquisition of OpenEye, we're increasing our focus in that domain and even moving a bit further up the food chain to what's called the enterprise space. The international itself is a driver and growing at a nice clip and I think probably will accelerate more next year than any year in the past. I feel like a lot of things are sort of about ready at the moment. And then we have the PointCentral business where I would think our – as a growth driver will be sort of steady state, next year continue to grow there. That team is moving into a couple of new segments. The biggest one being the multi-dwelling unit segment and I guess, I forgot EnergyHub is the other driver where – EnergyHub benefits from scale, the larger they become, the more relevant they become, the more utilities that are on the network. The more relevant they are to all the device makers. So that also is a growth driver for us. So those are kind of the key components of the picture that we look at. And we do a lot of bottom up modeling and then we do some top-down analysis on the segments and those are the segments that we're really focused on.

And my second question is about margins, EBITDA margins for 2020 in light of the investments. Steve, you talked about, I mean, should we model EBITDA flat margins next year or should we model EBITDA margins down. Can you give us some clear directional sense?

Yes, directionally. So I definitely wanted to cover that this quarter as we start thinking about next year. And I think the way I'm thinking about it, Nikolay is I'm thinking basically about where we are today. Good solid cash flow and I think solid EBITDA and I'm happy with the level we're at today. If I think about the contribution that would come from incremental growth, I start – so we do plan to grow next year that will generate some incremental contribution. And I think about basically accelerating some of our growth investments by plowing that incremental contribution back into the businesses is sort of the way I'm thinking about it.

Thank you.

Our next question comes from Kevin McVeigh with Credit Suisse.

Great. Hey, Steve, any sense of how much OpenEye impacted the quarter and then ultimately the rest of 2019?

So this is – Steve, you may correct me here. This is Steve Trundle. Had no impact on Q3 on the results we just reported because…

Yes, we closed it toward the end of October. This is Steve Valenzuela. So it didn't impact Q3 at all. And then in terms of how we looked at Q4, I think we've only sort of been in there for a couple of weeks. So modest – very, very modest impact on our model as we look at Q4 maybe a couple of million dollars were sprinkled in on the hardware and other side but not much. So really not much there. And then I think as Steve said, when we kind of think about the initial picture for 2020, we did model in some meaningful revenue from OpenEye on the hardware and other line into our 2020 initial look.

Got it. And then obviously there, would you think of kind of the EBITDA impact, would that be reinvested as well or that would be kind of growth in 2020?

Good question. Yes. Currently sort of – it's a business that is well run and has been run to conserve cash. And in some ways that drives a focus on selling software licenses as opposed to selling fast because you get your cash upfront. So it's sort of a nice break-even business at the moment. I think the way we think about it is we would say it's probably little under capitalized and we would prefer to capitalize the business better. Try to accelerate the growth and try to accelerate a shift to an economic model that drives down the upfront cost for the service providers and/or the end customer by shifting some of the software costs into a SaaS model that's more reflective of the way Alarm.com works. So the way we're looking at it is, while good healthy kind of could be a no impact type business where we're likely to accelerate investment into the business and would not be a massive headwind to EBITDA, but would be one of the things when I talked about, it’s not only some incremental profits back into the business, that would be one of the areas where I would expect to be plowing.

Got it. And then just to finish it out, how should we think about this within the context of the STANLEY partnership earlier in the year and how has that been scaling on the commercial side?

Yes, good question. I don't know that we've sort of matched those two initiatives just yet. I think in the case of OpenEye there, there are about 400 existing service providers and system integrators who are their partners. And there's very little overlap in that group. So the great thing is similar business model to us, but very little overlap in the actual established partnerships. And I honestly can't remember whether STANLEY is one or not. But what I would say is as we think about our service providers, we feel like and this is inclusive of all of them. We feel like the product that we're adding to our stack with OpenEye will be relevant particularly to those on the high end of the space. And you've identified one where they're needing to install in some cases a couple of hundred cameras on a given customer site. So that's where it's particularly relevant and there may be a fit there, but I don't think we've connected that just yet.

Great. Thanks so much.

Thanks.

Our next question comes from David Gearhart with First Analysis.

Hi, good afternoon. Thank you for taking my questions. I wanted to come back to OpenEye just briefly, a mix between hardware and license. Should we expect directionally a lift on the hardware and other gross margin side, as we go forward into Q4 and maybe in the next year?

Yes, good question. Steve, do you want to take that one?

Yes, I think the gross margins for OpenEye for hardware are higher than our typical gross margins. So there would be a little bit of a lift in the overall gross margins for Alarm.com. But basically I think it's around 25% of what we're going to be taking from OpenEye or what's contributing there is software, which is pretty high margin revenue relative to what we see on typical hardware revenue. So their contribution would provide us a bit of a tailwind on the gross margins on the hardware and other line item because such a meaningful component of it is actually software.

That's right.

Okay. Got it. And then I wanted to ask, Steve V, in terms of the tariff issue that's been talked about the last couple of quarters, what are you seeing on that front. And would you say directionally you're more positive on guidance or you're maintaining your expectations on the tariff front and in your current outlook?

We certainly have, as we've talked about in the past, we certainly have been incurring costs related to tariffs. We've been absorbing some of those. We've been able to pass some of that on. And so we still take a cautious view on tariff, we don’t know when the next tweet is going to come out, so we have to be careful. But I would say, we're just – we're being cautious when it comes to tariffs.

I would add a little color though, which is, it hasn't quite been the big event that maybe we expected it could be, there are material additional costs. We're incurring some of those costs, but does not seem to have affected demand. And I think that's probably because we and our service providers sort of figured out the right amount of these incremental costs that we should absorb and what sort of the right amount that the customer may be willing to absorb without materially altering demand. So, while they're still relevant and we look forward to them potentially going away, it hasn't really been the big event that I think maybe we were fearful of three, six months ago.

Okay. And then last for me, litigation expense, roughly $2 million, from the quarter down sequentially. Can you give us any sense of what we should expect, just in absolute dollars for litigation should we model flat for the next year on 2020? That's it for me. Thank you.

Yes, it's a really hard to predict litigation expense as you said for Q3 it was $2 million down compared to $5 million Q3 2018 if you exclude the TCPA settlement. So it does kind of bump around at around a $3 million to $5 million per quarter level depending upon when the events concur. So it's always hard to predict when litigation matters come to the higher level of the case. But I would say if you look at in 2018, litigation expense was around $17 million not including the TCPA settlement. In 2017, it was $7 million. And then in 2016, it was around $14 million. So going forward, I think if you're modeling around the historical range around the $14 million to $17 million, but again, that's a caveat with, it's very hard to predict what cases will come forward. It's hard to predict when the costs will be incurred.

Got it. Thank you.

Sure.

Our next question comes from Darren Aftahi with Roth Capital.

Hey guys, thanks for taking my questions. A couple if I may. First, I guess for Steve Trundle. You talk about investments, why strategically is now the right time to kind of reinvest in all of these areas of the business you kind of mentioned?

Yes, I think it's, because we have tipped our toes in the water in a number of domains. I think, one being commercial, one being international. I can say the same thing about the HVAC segment. So, so in a few cases that an energy hub for that matter, we have, we have been kind of playing delicately and not fully committing, but I think you do that and you basically wait for the business to show you that it's worthy of being filled. And I think we're at a point now where we feel more confident that a number of these efforts are worthy of capital allocation and will drive positive results with some additional scale. So that's one thing. The second I would say is, I feel like we've gotten to a healthy level of cash production that allows us to be sort of forward leaning at with our Corp Dev activities and I don't want to go to the point that we're entirely driving growth with Corp Dev when we have so many great organic initiatives that are also worthy of capital allocation. So, I think we're at a nice point in terms of mix of cash production in of positive points with a number of these efforts. And therefore, I thought now is a good time to, I think we're not saying tomorrow by the way. We still have three, four months of this year to go through and then we'll really get into the details of planning out next year. But I felt like now is a good time for us to begin to think about how we're going to operate the business next couple of years in terms of the...

And I would add to that, we've built a very good balance sheet. We have strong – Steve talked about strong cash flows. And again, if you look at last year, for 2019, the EBITDA is I think – as I had around the guide is over a $100 million, over $102 million about which is a good amount of EBITDA. This year, if you exclude the TCPA payments, we're going to probably generate about $65 million of cash flow, which is very good amount of cash generation. So, I think we're at the point where we've got the business with good balance sheet, good cash flow generation and so the opportunity there is given all the opportunities with commercial, with video analytics, with international, EnergyHub and PointCentral all of those are really coming to the forefront of being ready for investment that we think will yield growth for the future.

Great. That's helpful. A couple more if I may. Just with the integration of OpenEye, how do we think about your service provider base? I think in the past you've talked about I think it's well over a thousand and be [indiscernible] on your core commercial, but when you integrate these two platforms together, going into 2020, like it'd be a lot. How do we think about your service provider base vis-à-vis type commercial strategy?

Yes. So, I think that by early part of next year we will be providing a path for a set of service providers to become certified in the OpenEye solution as efficiently as possible and will enable those folks who service markets that are relevant to OpenEye to become OpenEye service providers. We'll make that easy for them. We'll do some integrations with various parts of our offering back into the OpenEye platform and vice versa. So we'll begin a couple things. There are some fairly low hanging fruit that we can go after initially in terms of simple integrations and then we'll get to work on probably the more sophisticated integrations on things like the video analytics piece. But so the nice thing is there's not a ton of overlap right now. I think there will be some service providers that we enable by the first quarter, second quarter assuming that they're interested and adding the OpenEye offering to their solution set. And that's kind of how we're thinking about it. The same time we think the business is good on its own and we want to avoid sort of interfering with the business or doing things that would cause it to change trajectory on where it is other than maybe what I discussed a moment ago where I talked about the value we see in driving down some of the upfront costs by shifting to a bit more of a SaaS model.

That's helpful. Thank you. And then lastly, just what was the other SaaS revenue in the quarter?

It was $5 million up about 45% year-over-year for other SaaS, for the other segment.

Great. Thank you guys.

Sure.

Our next question comes from you Nehal Chokshi with Maxim Group.

Yes, thanks. So this OpenEye acquisition is a pretty exciting, I think. And so a lot more questions on this first, was this a competitive process?

I'm sorry, what?

Was it a competitive process?

A competitive process? Yes, what I would say is that they had retained, they had a retained banking relationship that was exploring a few options. I think in terms of a strategic, we were the, we were sort of the only one that was invited to consider the situation. So yes, it was sourced. It wasn't, a big action but yes, so.

Understood. That's helpful. And then who would you consider OpenEye’s biggest competitor today?

There are a set of folks I want to avoid naming any single one but a set of fairly established traditional MDR players who deliver software and MDRs that normally sit onsite and allow you to monitor hundreds of cameras without really a lot of cloud apparatus included. So OpenEye already is a cloud oriented provider and that's really the big piece of differentiation is they allow you to manage the entire deployment through the cloud. If you want to share resources, you do that through the cloud. So it's already implemented as a hybrid cloud/on premise model. They've gravitated to more of an on premise traditional pricing scheme primarily because of the cash flow benefit that drives through a company that's self funded. But there are three or four large players that are in the traditional space. And then there are a handful of startups like OpenEye. I think on the destructor list OpenEye is probably the leader and there are a couple of others that are driving entirely cloud driven architectures. But I would say they'd probably have more traction than any of them.

Right. Are any of those established players Chinese vendors that have been recently put a place on the restricted list and maybe be creating some disruption that you guys can go and take advantage of?

Well, I think that – that dynamic creates some additional opportunity in that OpenEye is also is open, which means while they have eight to 10 of proprietary cameras that they offer, they support probably 12, 15 different partners who – when you go to a large commercial site, they don't want to be told that you need to replace all of the cameras they've installed over the last three or four years around the location so that you can run the OpenEye software. They want you to work with what's there. And that's driven the company to be fairly open and partner oriented, support a wide range of cameras, including a number who are not on any type of list or having, that may have any of those liabilities associated with them. So, that was another attractive element of this opportunity.

Got it. And then finally has the lack of the VMS or the VSaaS been an issue for driving the adoption of Alarm’s other commercial offerings?

I would say that not entirely, because we have not gone after the segments that they're focused on. So we've probably, we're working within a small, slightly smaller TAM than what is conceivable with the OpenEye solution. And in our case, a typical installation will be anywhere from two to 30 cameras. And the way the video is on the commercial side is consumed is normally through an iPad or an iPhone or some other mobile device. In their case, a typical installation could be hundreds of cameras that all need to be managed through a similar or through a single software stack. And the majority of it will be consumed by a person that's sitting in a guard station, with 30 or 40 different cameras alternating in the proprietary user interface. So, that part of the market that they serve, customers like Gonzaga University or Olive Garden, some of these large sort of distributed players, Bed Bath & Beyond that's a segment that we haven't really targeted with our commercial offering today. And therefore, I wouldn't say we've been hindered, but now we have an opportunity through OpenEye to target more of that segment.

Okay. Thank you.

Thank you.

Ladies and gentlemen, this concludes today's presentation. You may now disconnect and have a wonderful day.