Good day and thank you for standing by. Welcome to the Alarm.com Q3 2023 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] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Matt Zartman, Vice President of Investor Relations. Please go ahead.

Thanks, Kevin. Good afternoon, everyone, and welcome to Alarm.com's third quarter 2023 earnings conference call. Please note that this call is being recorded. Joining us today from Alarm.com are Steve Trundle, our CEO; Dan Kerzner, President of our Platforms Business; and Steve Valenzuela, our CFO. During today's call, we will be making forward-looking statements, which are predictions, projections, estimates or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. We refer you to the risk factors discussed in our quarterly report on Form 10-Q and Form 8-K, which will be filed shortly after this call with the SEC, along with the associated press release. This call is subject to these risk factors, and we encourage you to review them. Alarm.com assumes no obligation to update any forward-looking statements or information, which speaks as of their respective dates. In addition, several non-GAAP financial measures will be discussed on the call. A reconciliation of the GAAP and non-GAAP measures can be found in today's press release on our Investor Relations Web site. I will now turn the call over to Steve Trundle. Steve?

Thank you, Matt. Good afternoon and welcome to everyone. We are pleased to report that another quarter of solid responsibility. Our SaaS and license revenue in the third quarter was $145 million, up 8.9% over the same period last year. Our adjusted EBITDA in the third quarter was $41.4 million. I want to thank our service provider partners and the Alarm.com team for their continued strong performance. During the quarter, we meaningfully outperformed our SaaS target despite some softness and difficult-to-predict hardware revenue. The diversity of our business is worth highlighting as our growth initiatives continue to make substantial contributions to our SaaS results. As many of you know, we typically conclude our third quarter call by providing a very early look at how we think the business will perform in the following fiscal year. I'm going to keep my comments brief today, but provide some context to the 2024 numbers that Steve Valenzuela will outline. I'm also excited to welcome Dan Kerzner, the President of our Platforms Business, to the call to update you on a few product development initiatives. Before I hand things to Dan, I want to comment further on where we are strategically, and what we see in the year ahead. Overall, I am pleased with our growth in SaaS revenue this year, and our opportunity to maintain that momentum through next year. In 2023, we successfully accomplished some belt-tightening in the business, and have been able to produce the same adjusted EBITDA on a real dollar basis as in 2022. We achieved this despite an unexpected setback late last year that impacted our IP license revenues, and which generated material legal cost. Even as we made these adjustments, we continue to build strong businesses in commercial [intrusion] (ph) and access, residential and commercial video, and…

Thanks, Steve. I'm pleased to join our call today and speak with our investors and analysts. The Platforms Business includes all product development for our core commercial and residential platforms, as well as sales and marketing for our largest market, North America. We drive profitable revenue growth across global markets through new product releases that expand our market opportunity, increase ARPU, and build on our service provider partners' strong competitive position. While the team is focused on a range of technology domains, I use today's call to update you on several new enhancements to our user experience and video platform. Updates to our user experience have been motivated by the fact that the typical connected property solution on the Alarm.com platform has become increasingly sophisticated with more and different devices. This increase, particularly focused on video has influenced our subscribers' use and interface with their system. We continue to refine and optimize our user experience to provide frictionless and intuitive access to the information and commands that subscribers value most. During the quarter, we launched an enhanced version of our mobile app. The modernized navigation provides one-tap access to high-use features. Design also integrates a curated graphical activity feed that incorporate video clips directly into a comprehensive timeline of activity at the property. We also developed an enhanced interactive scrubbing interface for our continuous video recording solutions. This is a crossover feature that both increases visibility for residential customers, and fits the commercial market. The use cases for commercial subscribers include quickly checking to see which employees opened or closed a store on time or tracking unexpected entries or exits to an office. Enhancements and new capabilities designed into the mobile app were informed by our extensive subscriber usage data. In a single month, earlier this year, nearly 100 million…

Thanks, Dan. I'll begin with a review of our third quarter 2023 financial results and then provide our guidance for Q4 and full-year 2023 and conclude with our initial thoughts on 2024 before opening the call for questions. Third quarter SaaS and license revenue of $145 million grew 8.9% from the same quarter last year. Excluding Vivint license revenue, third quarter 2023 non-GAAP adjusted SaaS and license revenue grew 13.9% year-over-year on a comparable basis. SaaS and license revenue includes Connect software license revenue of approximately $5.7 million for the third quarter, down as expected from $6.5 million in the year-ago quarter. Our SaaS and license revenue visibility remains high, with a revenue renewal rate of 93% in the third quarter, consistent with our historical trends. Part of another revenue in the third quarter was $76.8 million, down 7.5% from Q3 2022, as the year-ago quarter benefited from heavy LTE cellular module sales in advance of the 3G cellular sunset that occurred at the end of last year, and some slowing of hardware sales in the commercial enterprise market. Total revenue of $221.9 million for the third quarter grew 2.6% year-over-year. SaaS and license gross margin for the third quarter was 84.9%, up slightly quarter-over-quarter from 84.6%. Hardware gross margin was 22.6% for the third quarter, up from 19.1% in Q3 2022, mainly due to favorable product mix and improved supply chain dynamics. Total gross margin was 63.3% for the third quarter, up from 60.4% in the year-ago quarter, mainly due to the improvement in hardware margins. Turning to operating expenses; R&D expenses in the third quarter were $61 million compared to $55.6 million in Q3 2022, mainly due to an increase in headcount and related compensation expenses. We ended the third quarter with 1,116 employees in R&D, up from…

Thank you. [Operator Instructions] Our first question comes from Adam Tindle with Raymond James. Your line is open.

Okay, thank you. I'm just trying to do the fast math here on that guidance here, Steve. Well, curious what it implies in terms of the drivers of the SaaS line. In particular, obviously, ADT has been a little bit more public about their roadmap here. It looks like, if I did the math correctly, you're going to be guiding to about 8%, or at least the initial thought, perhaps for SaaS growth for 2024 is around 8%, which is very healthy coming off of a 9% comparison, so not much deceleration. And I know you tend to be conservative on that. So, maybe just some of the drivers that led you to this initial look on 2024, in particular what the ADT assumption is in there?

Hey, Adam, this is Steve Trundle. I'll start with the ADT assumption. And then if Steve wants to pick up on anything else. But, yes, you did the math correctly first, so that's right. And we're using the same, I think, data points that others have on ADT, where public communication has been that they're going to initiate some activity by the end of this year with the transition. So, what in our model we're doing is, we have that activity, meaning that transition, modeled in to occur mostly in the first quarter of next year, sort of to begin late this year, and then roll through the early part of next year.

Yes. And then Adam, you're right, it's about 8% growth we're projecting. And as we always do in the initial look, it's 15 months out, so we're giving ourselves some room here for hopefully some beat-and-raise. And there is challenging macroeconomic environment out there, I mean we've done quite well. But if you look at last year, the initial look, we initially guided to about 6.3% growth, and we're coming in at about 8.6% for the year. So, we always have some room that we allow ourselves there to be able to do a beat-and-raise during the year.

Great, yes, that's clear. And it looks like a healthy initial look. I guess maybe a question on the quarter. You had alluded to the hardware piece. And I know that the story is more about the SaaS line here for Alarm.com. But do want to ask a little bit more on hardware, if you could unpack some of the drivers that led to weakness in the quarter? And if I look at the Q4 guidance, it looks like it might be flat to slightly up sequentially, if I did the math right on there, for the full-year. I know Q4 is typically a little bit of a seasonally soft hardware quarter given weather, and installs, and stuff like that. So, looks like maybe some temporary items in Q3, and healthier Q4 outlook. Wonder if you could unpack the drivers in the hardware piece, and assumptions? Thanks.

Yes, so that's right, pretty much flat Q4. The drivers there were, and really into looking into next year, first starting with this year, a little bit of weakness in the commercial enterprise space. We just -- it's not that we're seeing orders go away, we're just seeing the cycle taking longer than we expected. So, in the last quarter, we saw a little weakness there. We had a couple of little supply chain issues, a little more modest. And then even on the residential side, we're seeing couple things going on. First, many, many fewer LTE modules being sold because the upgrade cycle from 3G to LTE is mostly over at this point. So, that's kind of been drying up. And then the last on the hardware side would just be the macro conditions are creating a world which is sort of good and bad for us in a way where you're having fewer moves on the residential side, so you're not doing as many new installations necessarily. But you're also having less churn on the residential side, where we expect probably revenue retention will trend up a little bit. So, that's -- but you see slightly less hardware on that side as well.

Got it, thank you.

[Operator Instructions] Our next question comes from Saket Kalia with Barclays. Your line is open.

Okay, great. Hey, guys, thanks for taking my questions here. Steve Trundle, maybe for you, can you just talk a little bit about the growth businesses that you touched on last quarter? I can't remember if it was 30% of the business growing at 25%, or vice versa. But it was a really interesting stat. I don't expect it to change much in just one quarter, but curious if you could just expand on what you're seeing in a couple of those biggest growth businesses?

Yes, the first year recollection is correct, that, I think, what we communicated last quarter was 30% of the -- the growth businesses represented around 30% of the SaaS, and we're growing at around 25%. So, that's continued. The drivers there really EnergyHub being one, where did recently put out a press release about this past year being really sort of a record-setting year for us with the number of events called and the number of -- I think it was over 1,800 events we've called year-to-date, meaning demand response events on behalf of utilities. And moved around quite a few gigawatt hours of power, I believe more than 200% more power we moved off the grid at key moments this year versus last year. So, just seeing a lot more usage there which allows us to keep growing that business. And then the team is focused right now on expanding into the broader resource space to include EVs in particular, so a lot of work going on there. And we see that as sort of another growth vector in that business. The other couple places are the international business, which continues to clip along at roughly that same growth rate. In terms of their SaaS growth, can be a little lumpy. But we still see mostly green fields internationally, where we're in the early days of a bunch of new relationships and trying to help partners get up to scale, and to adopt the full platform, sort of move from the basic interactive security offering to a full offering that includes video and elements of our automation solution. And then the next would be just the overall commercial play, both commercial intrusion, commercial access, I guess I should say also commercial video, still fairly early there for us. Continue to make good headway there, both in our core business and with the OpenEye video segment. As I noted in my comments, and as Steve noted, in the third quarter there was a little bit of a slowdown in the amount of hardware being sold through that channel. But overall, SaaS growth rates were the same. And we expect that to continue, and to give us some tailwinds next year.

Got it. Maybe for my follow-up, for you, Steve Valenzuela, so always very helpful to get a preliminary look at next year, here in Q3. And I know it is preliminary, but curious how you're thinking about legal costs for 2024?

Yes, it's a good point. Clearly we have factored in some legal costs. It's important to point out though that a good portion of the legal spend for the major programs are now adjusted out. They get to a certain stage, so we've factored that out -- that into our adjusted EBITDA guide.

Got it, very helpful. Thanks, guys.

Thank you.

Thank you.

[Operator Instructions] Our next question comes from Darren Aftahi with ROTH. Your line is open.

Hey, guys, thanks for taking my questions, and congrats on the quarter. If I could double tap Steve Trundle on the commercial comment, I'm just trying to understand the relationship between is the sort of cycle for hardware a little elongated, and that's what contributed to maybe some of the weakness in the quarter, but the underlying strength for the commercial demand is still there. Am I hearing that correctly?

Yes, Darren, that's what I was attempting to communicate. So, we -- and again this wasn't a major pullback, but it was just enough that it was sort of noticeable. And we just -- from what we can tell, really beginning sort of mid-August, we starting seeing some slower or delayed purchasing cycles, where orders that were in process might normally close in three or four weeks, seemed to drag on, drag out of the quarter. So, that that's sort of what I think we saw. And the second-half of the third quarter is just tapering of intensity at the enterprise level primarily, meaning larger customers, large facilities, large, big box retailers, quick serve restaurants, places like that that would typically be installing at a certain rate. That's pretty predictable. That rate came down a bit in the second half of the third quarter. We assume, we don't know, but we assume like many people, that folks are kind of trying to get a read on the overall economy right now and thinking about the velocity of their CapEx expenditures and whether it's better to be in conservation mode or better to be in sort of growth mode at the moment. So that's our best guess. But we saw just a little bit of a slowdown in the third quarter in that space.

That's helpful. Thank you. And then maybe one for Steve Valenzuela, your free cash flow number is exceptionally strong. I'm just curious with the collections and the DSOs. I mean, is that a sustainable sort of working capital sort of pass-through beyond adjusted debt income? I mean, how should we think about free cash flow in the fourth quarter based on the implied guide?

Yes. Q3 certainly was an extraordinary cash flow quarter. Everything came together. We can't expect that on an ongoing basis. Q4 typically would be -- when we hear cash flow quarter, there is seasonality in that as well. So Q3, we had very favorable DSOs. We had inventory come down a bit. Q4, we also have the potential tax payment related to the new tax rules around R&D capitalization, which might have to be paid if Congress doesn't change that rule. And so, yes, Q3 is certainly an extraordinary quarter for cash flow. But generally, if you look at the year-to-date cash flow of around $90 million, generally, on a normal basis, the year-to-date or the year cash flow usually is around $90 million to $100 million. It's just that Q3, everything came together and generated that amount of cash flow.

Got it. Thank you.

Thank you.

One moment for our next question. Our next question comes from Matt Bullock with Bank of America. Your line is open.

Hi. Awesome. Thanks. Yes, I'm on for Mike Funk, great to see the strong EBITDA performance. I'm curious if you could provide us an update with whether or not the Vivint impact to revenue EBITDA and, I guess, legal expenses has tracked with the initial guidance you provided. I guess, it was about a year-ago. Just trying to parse through whether or not some of this strong EBITDA performance is related to potentially lower legal expenses or how that's evolving. Thank you.

Sure. Hey, Matt. Yes. The EBITDA performance comes from a little bit stronger business than we expected at the beginning of the year. I would say success in executing on some belt-tightening initiatives and driving more profitability in the business. But we also did get some benefit, I think, at the beginning of, you kind of referenced about a year-ago, when that private matter came up initially. We didn't really know. I think, I probably said, I don't know exactly how broad or how intense our legal burdens would be, but I've got a budget for it at a week ago, a reasonably aggressive level. So we did budget for it. We haven't burned at quite the level. I think I telegraphed ballpark-ish $16 million on that at that time for this year. And we haven't burned at quite that level, but we've burned a healthy amount, and it's still an ongoing matter in the years. The year's not done, but I'd say it's been a little less intense than what I anticipated.

Super helpful. Thank you.

Just one moment for our next question. Our next question comes from Matthew Pfau with William Blair. Your line is open.

Okay, great. Thanks. I'll just ask for one more clarification on the legal expenses. There was a decent sequential uptick. What drove that in the quarter?

There is a lot of legal activity going on. As you can see, you'll be able to see in the 10-Q. And so it's really hard to predict the legal expense, right, because depending on the timing of events and circumstances, so it's very difficult to predict. But yes, it was up in the third quarter. I think it was $5.9 million compared to $3.1 million a year-ago. And so, it will fluctuate quarter-to-quarter depending upon timing of certain events.

Okay, got it. And then as we think about the hardware guidance for 4Q and for 2024, does ADT rolling off to its own platform have any impact on the hardware line, or is that just on the subscription line?

No, that also impacts the hardware line, and that is in our initial look model that we provided, so we would expect to see fewer devices, cameras, doorbells, et cetera, being sold as they execute their transition, so it does have an impact on the hardware line.

Okay, great. Thank you.

Ladies and gentlemen, that concludes the Q&A portion of today's conference and also includes the conference itself. You may now disconnect and have a wonderful day.