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Operator
Good day and thank you for standing by. Welcome to the Alarm.com Q2 2023 earnings conference call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again. Please be advised that this conference is being recorded. I would now like to hand the conference over to your speaker today, Matt Zartman. Please go ahead.
Matt Zartman
Good afternoon, everyone, and welcome to Alarm.com's second quarter 2023 earnings conference call. Please know that this call is being recorded. Joining us today from Alarm.com are Steve Trundle, our CEO, 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 risk 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 these risk factors. Alarm.com assumes no obligation to update any forward-looking statements or information which speak 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 website. I'll now turn the call over to Steve Trundle. You may begin.
Steve Trundle
Thank you, Matt. Good afternoon and welcome to everyone. We're pleased to report that our second quarter results exceeded our expectations. SAS and license revenue in the second quarter was $140.4 million, resulting in a non-GAAP growth rate of 13.3% over last year, excluding by then. Our adjusted EBITDA in the second quarter was $36.4 million. I want to thank our service provider partners and the Alarm.com team for their contributions to our results and for their ongoing performance. Our increasingly diverse business continued to grow despite uncertain macro conditions. Our SaaS outperformance was driven by our growing subscriber base and increasing contributions from our growth initiatives. Hardware outperformance was driven by sequential growth in the volume of camera cells consistent with solid account creation during the quarter and normalized channel inventory levels. Our stronger than expected adjusted EBITDA line was driven by an increased focus on controlling cost, along with the higher performance in SAS and hardware revenues. In terms of our operations, we continue to focus on our growth strategies as we exploit the opportunities we see in commercial, international, video, and our venture businesses. Collectively, SAS revenue from these initiatives is growing faster than our total SAS at about 25% on a trailing 12-month basis. We're carrying nice momentum into the back half of the year, and I believe we are well positioned to execute our annual plan. On today's call, I want to provide a few product updates around our video services platform and the development of our commercial business. I'll begin with the video services platform. In the second quarter, we introduced a new video doorbell called the VDB 750. Now with three alarm.com developed products in the market, our video doorbell lineup offers our service providers unmatched choice, flexibility, and performance options. This should allow us to drive up the attachment rate of our video doorbells through time. We believe the 750 is the first battery-free video doorbell on the market. As you may know, even wire-powered video doorbells still embed and require a small battery that must be replaced periodically. With no consumable parts, the 750 is the lowest maintenance video doorbell product that service providers can install. Embedded batteries also restrict the typical video doorbell operating temperature range. The new 750 has an operating temperature range that is as much as 70 degrees Fahrenheit wider than other leading video doorbell brands. That's particularly important to our service providers in both the far north and the southwest. The 750 became generally available in the second quarter, and we expect it to be adopted quickly as our service providers integrate it into their offerings. Our investments in video software and cameras are consistent with the opportunity we are seeing. In the last two years, we've seen a double-digit growth rate in the number of Alarm.com video cameras that our service providers install monthly. Adding our video solution to a subscriber's account contributes to higher ARPU and supports an 8 to 10-year SAS revenue stream. I'll now shift to discuss a significant enhancement we have made to our partner services platform so that our service providers can better manage their commercial customer accounts. As a reminder, our partner services platform is a broad suite of remote management software, resources, and business intelligence solutions. We designed these capabilities to help our partners operate more efficiently while deploying more devices and services to their customers. We put a lot of effort into wrapping our consumer-facing technology with backend services and software that enable service providers to be successful with their broad deployment of our products. This quarter, we expanded the business intelligence component of our partner services platform to provide new insights into commercial account performance. Our data science team was able to model historical account characteristics and identify discrete attributes that are closely associated with lower customer attrition and greater everyday system engagement. These insights were then rolled into a set of six specific best practices. Our service providers can implement these practices to increase customer lifetime value from their high ARCU commercial accounts. They can also monitor implementation in their commercial account base and identify opportunities for additional improvements using our business intelligence reporting engine. In summary, I'm pleased with our second quarter results and our execution of our plan through the first half of 2023. We continue to expand our platform and market opportunity with the launch of innovative new products and the occasional acquisition that aligns with our long-term growth strategy. I want to thank our service provider partners and our team for their hard work and our investors for their continued trust in our business. And with that, let me turn things over to Steve Valenzuela to review our financial results and provide guidance. Steve?
Matt
Thanks, Steve. I'll begin with a review of our second quarter 2023 financial results and then provide our updated guidance before opening the call for questions. Second quarter SAS and licensed revenue of $140.4 million grew 8.5% from the same quarter last year. Excluding Vivint license revenue, second quarter 2023 non-GAAP adjusted SAS and license revenue grew 13.3% year-over-year on a comparable basis. SAS and license revenue includes Connect software license revenue of approximately $5.9 million for the second quarter down as expected from $6.9 million in the year-over-quarter. Our staff and licensed revenue visibility remains high, with a revenue renewal rate of 93% in the second quarter, consistent with our historical trends. Part or another revenue in the second quarter was $83.4 million, at the same level as Q2 2022, and up $9.1 million or 12.3% quarter-over-quarter, mainly due to an increase in sales of cameras and access door controllers. Total revenue of $223.9 million for the second quarter grew 5.2% year-over-year. SAS, the license gross margin for the second quarter, was 84.6%, down from 85.6% in the year-ago quarter, mainly due to lower license revenue. Hardware gross margin was 22.4% for the second quarter, up from 17.7% in Q2 2022, mainly due to favorable product mix with more commercial offerings. Total gross margin was 61.4% for the second quarter, up from 59% in the year-ago quarter, mainly due to the improvement in hardware margins. Turning to operating expenses. R&D expenses in the second quarter were $60.9 million compared to $54.2 million in Q2 2022, mainly due to an increase in headcount and related compensation expenses. We ended the second quarter with 1,053 employees in R&D, up from 919 employees in Q2 2022. Total headcount increased to 1,909 employees for the second quarter compared to 1,606 employees in the year-ago quarter. Sales and marketing expenses in the second quarter were 23.8 million, or 10.6% of total revenue, compared to 22.9 million, or 10.8% of total revenue, in the same quarter last year, mainly due to increased headcount. Our G&A expenses in the second quarter were 28.8 million, down slightly from $29.3 million in the year-ago quarter due to lower headcount and compensation costs partially offset by higher legal fees. G&A expenses in the second quarter includes non-ordinary course litigation expense of $1.3 million down from $5.3 million in the year-ago quarter. Non-ordinary course litigation expenses are part of our adjusted measures and are excluded from our measurement of our non-GAAP financial performance. In the second quarter, GAAP net income was $15.8 million compared to GAAP net income of $10.8 million in the year-ago quarter. Non-GAAP adjusted EBITDA in the second quarter was $36.4 million compared to $37.1 million in Q2 2022. Non-GAAP adjusted net income was $26.6 million or 49 cents per diluted share in the second quarter compared to $26.9 million, or $0.49 per share, for the second quarter of 2022. Turning to our balance sheet, we ended the second quarter with $627 million of cash and cash equivalents, up from $622.2 million at December 31, 2022. During the quarter, we used $6.7 million to repurchase 134,255 shares of our common stock at an average cost of $50.11. Turning to our financial outlook, for the third quarter of 2023, we expect SAS and license revenue of $141.4 to $141.6 million. For the full year of 2023, we now expect SAS and license revenue to be between $562.3 to $562.7 million, up from our prior guidance of $555.9 to $556.5 million. We are projecting total revenue for 2023 of $872.3 to $887.7 million, increased from our prior guidance of $855.9 to $881.5 million, which includes estimated hardware and other revenue of 310 to 325 million. We estimate that adjusted non-GAAP EBITDA for 2023 will be between 128 to 131 million, up from our prior guidance of 120 to 125 million. We expect adjusted non-GAAP EBITDA for the third quarter of 2023 to represent approximately 23.5 to 24% of our annual guide. Adjusted non-GAAP net income for 2023 is projected to be $92.2 to $94.2 million, or $1.69 to $1.73 per diluted share, up from our prior guidance of $84.6, $87.5 million, or $1.55 to $1.60 per diluted share. EPS is based on an estimate of 54.6 million weighted average diluted shares outstanding. We currently project our non-GAAP tax rate for 2023 to remain at 21% under current tax rules. We expect full-year 2023 stock-based compensation expense of 52 to 54 million. In summary, we are focused on executing on our strategic business plan and investing in our long-term strategy while continuing to deliver profitable growth. And with that, operator, please open the call for Q&A.
Operator
Thank you, ladies and gentlemen. If you have a question or a comment at this time, please press star 1-1 on your telephone. If your question has been answered or you wish to move yourself from the queue, please press star 1-1 again. We'll pause for a moment while we compile our Q&A roster. Our first question comes from Michael Funk with Bank of America. Your line is open.
Michael Funk
Hi, yeah, this is Matt Bullock on for Mike Funk. Thanks for all that color on the call. I'd love an update on international progress, specifically the progress you've made with signing new service providers and an overall update on how you expect international revenue growth to trend over the next couple of years. Thanks.
Steve Trundle
Hey, Matt, this is Steve Tundell speaking. So international growth, I think last quarter we indicated that growth was around 25% in that business overall. That's right. And we're not going to update this quarter, but I think we've seen that trajectory sort of continue. In terms of signing new service providers, we're out all the time and feel like we have a nice pipeline and some additional ones that are going to come on towards the end of this year. Can we sustain 25% sort of the next two years as a growth rate there? I think it's conceivable. That certainly would be our goal. So business is going to continue to grow and become a more meaningful chunk of the Alarm.com revenue base. If you look at international today, it's between 4% and 5% of total revenue. And our long-term target there is something probably in the 30% plus range. So We think there's plenty of runway, and we're out building that business every day.
Michael Funk
Excellent. Super helpful. And then one more, if I could. Could you provide a little bit of additional context on what commercial ARPU looks like today versus your standard residential ARPU? And then as we move through 23 and 24, maybe even 25, how that ARPU – You know, could it increase as you add more products and services?
Steve Trundle
Yeah, good question. So the rule of thumb today is that commercial ARPU is around 2x the residential ARPU. You have to remember in our case that the place where we're currently strongest commercially is really small business. So the average site, if we're doing access control, may have three or four doors that we're doing. today on average. That doesn't mean we can't take down installations where we're doing 80 to 100 doors, but on average today, we're probably stronger on the SMB side than we are on the larger enterprise side. As we continue to build out and deploy with OpenEye, with SDS, and with the rest of our commercial platform, I would expect that we'll have some gradual lift in that ARPU, and over time, commercial would probably be closer to, you know, there will be accounts, there will be outliers where it's, you know, 25, 30 times our standard residential ARPU, but on average, you'll probably see it drift up to something closer to the 3x over a long period of time.
Michael Funk
Super helpful. Thank you very much.
Operator
One moment for our next question. Our next question comes from Saket Khalid with Barclays. Your line is open.
Saket Khalid
Okay, great. Hey, good afternoon, guys. Thanks for taking my questions here, and nice revision to the guide. Thank you. Absolutely. Steve Trundle, maybe to start with you. You know, on the back of the last questions, I want to zoom out a little bit. You talked about growth initiatives on the whole growing at about 25%, and you prepared remarks. I think that's really interesting. Can you just maybe talk about how big that business is in total and maybe rank order the components of that growth business as we just think about the drivers? Does that make sense?
Steve Trundle
Yeah, that absolutely makes sense and good question. In terms of the overall scope of what we describe as the growth initiative, it's today around 30% of our total revenue. And we bucket into that bucket commercial, video, energy hub, and international. So those are really the four key pillars of what we today characterize as growth initiatives, and we talk about that particular growth rate that I mentioned in my prepared remarks. So in terms of, and that gives you a feel for sort of the scale, and it's getting sort of bigger, that bucket, every quarter, obviously. In terms of ranking them, it's hard for me to rank them in terms of preference because I like each of those areas as long-term growth drivers in the business. In terms of where we are today, I would say in terms of size that video and commercial are the two larger components of that mix. After that, it would be Energy Hub, which is growing nicely and is probably in the number three spot there, and then international not far behind in the number four spot in terms of rank ordering them on today's contribution. Does that help?
Saket Khalid
Yeah, that does. That's really helpful, actually. Steve Valenzuela, maybe for the follow-up for you and somewhat related, is there a different margin profile for these growth businesses? I mean, I know that those are all very different, and, of course, they're all fast. But I'm just curious, as we think about that 30% inching up to 35% into 40% in the quarters and years ahead, how might that increasing mix impact margins here as those growth businesses get bigger?
Matt
Yeah, Steve kind of talked about most of those growth businesses are in the Alarm.com segment. We have SaaS gross margins in the mid-80s. In the other segment, which includes Energy Hub, Generally, that gross margin is a little bit lower, generally in the 65% to 69% range, in the mid to upper 60% range. So as the growth business continues to grow, we might see a little bit of a drop in the gross margin. Matter of fact, if you look at Q1 versus Q2 of 2023, gross margin did come down a little bit on SAS, only about 80 basis points. Some of that is because the other segment actually is now 9% of our revenue, which is great news. It was 8% a year ago. And so there'll be a little bit of an impact, but I wouldn't expect more than 100 to 200 basis point impact on the SAS gross margin.
Steve Trundle
And then just to pile on, Steve's talking about the SAS. On the hardware piece, these areas, particularly the commercial side, tend to generate a little higher margin on hardware revenue. That's just sort of normal courses that... hardware in the commercial sector is, at least today, we're driving margins more in the 30% to 40% range there.
Matt
Yeah, that's a good point. So what I was talking about was all SaaS gross margins, hardware gross margins, generally in commercial, you know, are in the 40% range, as Steve was talking about.
Saket Khalid
Got it. Super helpful, guys. I'll get back in queue. Thank you.
Operator
Thank you. Thanks. One moment before our next question. Our next question comes from Jake Norseman with Raymond James. Your line is open.
Raymond James
Okay, perfect. Thank you guys for taking my question. Just a couple from me. If you could provide more color on the renewal rate, I know it's sort of hovered near that 93%, 94% for a few years now. How high could this go? Do you have any long-term targets? And what would be the puts and takes for driving that number up?
Matt
Generally, it's been 92% to 94% has been the renewal rate, and that's the revenue renewal rate. We did see it at one point during COVID at 94%. That's when there was fewer moves. You know, I think it's important to point out generally when there's fewer moves, there's less attrition. So that does contribute to a higher renewal rate. Also, I think that, you know, as we have video, video analytics, those are very sticky. And, you know, think about that those really came out about four years ago and the lifetime of a customer is eight to 10 years. So over a long period of time that these, enhanced services, I would expect that we would see a higher retention rate. Now, it takes time because you've got, you know, 9 million subscribers over a long period of time. It's like moving a large boat, right? It takes a while to shift over. But over time, we should see an increase in that retention rate as all of these value-added services really cause even a longer lifetime. Already today, we have an 8 to 10-year life, which is pretty long. So over a long period of time, I would say I would be surprised if the retention rate doesn't go up.
Raymond James
Okay, perfect. I appreciate that color. And then last one from me. Just from a higher level, could you talk about the puts and takes of returning to that 20% plus even a margin range and maybe how we should think about that for fiscal 24?
Steve Trundle
Sure. I guess higher level means me. This is Steve Trudell speaking. Sure. I think you've seen us, you know, in the last quarter, we were able to come in a little better on adjusted EBITDA than we expected. There was some, you know, increased focus on cost, and they had some output on both SaaS and hardware revenue that contributed to that. In terms of the margin profile in the business, you know, it's a little early for us yet to really forecast exactly what we're going to do in 2020. 2024. I don't want to shy away from the question, but I would say generally I look at what are the items that, you know, what do we have on our stack and where are we in the growth cycle and the various initiatives we have underway and what sort of investment makes sense. We don't want to get so enamored with, you know, investment that we don't deliver even, but we're looking, you know, more in the We'll kind of move towards that direction, but I think our internal guideline that we shoot for is more in the 17, 18% range right now. Perfect.
Raymond James
That's very helpful. Congrats on the quarter, guys. Thank you.
spk03
Thank you. Thank you. One moment for our next question. Our next question comes from Matt Fowle with William Blair. Your line is open.
Matt Fowle
Thanks for taking my questions. I wanted to ask on the Gopher product you released and some of the AI functionality that you're incorporating with your service providers. Does this help you on the cost side at all? And if so, is it meaningful enough to help you out from a margin perspective at all?
Steve Trundle
I would hope that through time this helps us on the cost side. Right now, our focus is really on enhancing the services and the experience that our service providers have when they seek support or help from us. But one can imagine that as the service providers become more comfortable interacting with Gopher, when Gopher delivers results faster and as good as a person, that we may see some shift to to the AI interface, and that could help us on the support side of the cost equation. That said, we've built our business around doing the best we can to provide high-quality support to the service providers. It's important for us to do that if we're continuing to ship new products. They need to feel like if we work with Alarm.com and we're out there with a new product, that we can get great support on it. We're going to continue that as sort of the number one priority, but I can imagine that with what we're doing with AI, that over time we could see some reduction in in-person call volume. I think there also are opportunities, though, with the large libraries to do some additional things internally, and we've got a number of initiatives that are maybe not as customer-focused, but just in terms of our own processes and things we work on every day to take better advantage of some of the AI capabilities there. And then, of course, the other piece of AI is what we do with video analytics, and we've been doing that for a long, long time. But there we're productizing the capability and putting it out in the market.
Matt Fowle
Got it. And I wanted to circle back to your comments around the new video doorbell that you released. Maybe if you could just give us some sort of idea what attach rates of video doorbells to subscribers have been, and then with the release of this product, is that going to move that up meaningfully in your view?
Steve Trundle
Yeah, good question. That's our hope. So we have a good product today out in the market with video doorbell. We have taken feedback from service providers that in some markets, Particularly those that have a lot of temperature extremes, they're challenged when they install a video doorbell. If you have a south-facing exposure on a home and you have a front door there and it's 130 degrees outside or even 110 with a lot of direct sunlight, it could be a challenge. So 750 solves that. Our goal would be to drive up attachment. Attachment's been in the 25% to 30% range. And we think there's an opportunity to get that probably over time closer to the 40, 50% range. Some homes already have doorbells. The nice thing is even if they have a third-party doorbell today, it doesn't exclude us from providing the smart home experience. It's just we may not replace the existing doorbell. But we're seeing cases where the existing doorbell is usually not our own. So when I refer to existing doorbell, I mean third-party products. where those are broken as well or not working well etc so hope is that with the 750 we can you know drive up that attachment also reduce the likelihood I mean we're constantly focused on ways to reduce attrition so if you have a product in the market that that causes a problem for the consumer there's a risk that you no longer are able to build services associated with that product so we want to drive down any sort of revenue attrition that may come from doorbells that go dormant because either their battery is bad or they weren't prepared to handle either the extreme heat or the extreme cold.
spk03
Perfect. Thanks for taking my questions.
spk00
Sure.
Operator
One moment for our next question. Our next question comes from Darren Aftai with Roth MKM. Your line is open.
Darren Aftai
Hey, guys. Thanks for taking my questions, and congrats on the results. Question for you, DT. Maybe, I think at ISC West, you guys announced the LTE Cell Connector, and I think you made some comments about strengthened hardware being related to door controller access. I guess, got any update there, and are those two connected?
Steve Trundle
Yeah. So we got CellConnector out in the second quarter. It's now being installed. Has it been a primary driver of the beat on hardware? No, it wasn't a primary driver. But the access control business is growing nicely in the mid-40s range, and that's continued now. And I think CellConnector is contributing to that growth. It's one more way that a service provider can attack an installation you know, with our products and bring a new subscriber onto our services. So the product is out. It's selling. I just can't say that it by itself was a primary driver. I think Steve mentioned the door controllers probably were, you know, a bigger driver because they're a bigger chunk of the average installation. And then video cameras were the second driver on the hardware beat. That's helpful. Thanks.
Darren Aftai
And then just kind of big picture, just given the housing market with interest rates and lack of supply, I'm just curious, like, is that having a beneficial effect to your retention rate? And then on the inverse, are you seeing a slowdown in residential sort of new gross ads?
Steve Trundle
Yeah, two-part question there. In terms of the interest rates impacting attrition, Traditionally, you're exactly right that if you have fewer moves in a market, then you will have typically lower attrition and you may have a slightly subdued creation rate as well because there are fewer new homeowners being originated. We haven't really seen that yet on either front. As far as we can tell, the builder channel for us looks pretty strong. Builders continue to build a fair number of homes. There's been a nice backlog there. So we haven't really seen yet a decline in terms of production going into new homes. Now, it's not a huge chunk of our business, but it's 50,000, 60,000 new installs a year, so it's meaningful. We haven't seen that rate really drop. In terms of attrition due to higher interest rates, I don't think we've necessarily seen a positive tailwind there yet. It's been sort of steady state as evidenced by our revenue retention metric.
spk03
Sure enough. Thank you.
Steve Trundle
Sure.
spk03
One moment for our next question. Our next question comes from Jack Cadera with Maxim Group. Your line is open.
Jack Cadera
Hi, guys. This is Jack Cadera calling in for Jack Vanderaardy. Thanks for taking my questions. I kind of want to elaborate on that last question that was asked. Last quarter, you guys talked on some macro trends, one being, you know, activation seems strong, but consumers in some areas, some regions, had maybe a slightly smaller footprint on number of devices year over year. You know, given your guys' guidance phrase, It seems like maybe that's not the case anymore, but are you still seeing that trend play out? Are you able to quantify that at all?
Steve Trundle
Thank you. Yeah, good memory. So I think that we've seen over the last quarter, I mean, we were a little surprised ourselves by the outperformance on hardware during the quarter, again, driven heavily by video camera sales. So So it seems like the consumer, there's really possibly two explanations there. One is the consumer has kind of returned to normal, if you will, a bit in the second quarter. The other is just that the inventory levels being held by service providers normalize some during the quarter. And I'm not sure we have an update on exactly which of those two is the more likely contributor. Could we measure it? Yes. Do I have the measurement in front of me right now? The answer is, unfortunately, I don't.
Jack Cadera
No worries. That's a helpful color. My apologies if this is another kind of non-question, but I'd also be interested to hear, on a regional side, you guys mentioned that Canada was performing strangely well, but you didn't really know why that is. Have you guys been able to figure that out at all?
Matt
Canadian market, you're talking about? Canadian market has been a good performer for a while, so not surprising to us.
Steve Trundle
I think he's referring back to prior quarter maybe where we had a Q&A on that or something. But no, Canada has continued to be strong for us. I think if I were to say why, it would be that we have the right service providers in Canada. We've been in the market a long time. The consumer appears to have been resilient there. We haven't really seen any drop-off, I would say, in contribution coming from Canada. So it continues to be a good market.
Jack Cadera
Thank you. I'll hop back in here.
Darren Aftai
Thank you.
Operator
Thank you. And I'm not showing any further questions at this time, so this does conclude today's presentation. You may now disconnect and have a wonderful day.
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