Alarm.com Holdings Inc

NASDAQ:ALRM

Earnings Call Transcript 2018-Q3

[Operator]

Good day, ladies and gentlemen and welcome to the Alarm.com Q3 2018 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded.

I would now like to introduce your host for today's conference call, Mr. David Trone. You may begin.

[Dave Trone, Vice President-Investor Relations]

Thank you. Good afternoon, everyone, and welcome to Alarm.com’s third quarter 2018 earnings conference call. As a reminder, this call is being recorded. Joining us today from Alarm.com are Steve Trundle, President and CEO; and Steve Valenzuela, CFO.

Before we begin, a quick reminder to our listeners. Management’s discussion during the call today will include forward-looking statements, which include projected financial results or operating metrics, business strategies, anticipated future products and services, including future innovation and video analytics, computer vision and artificial intelligence; anticipated investment and expansion; anticipated market demand or opportunities, including expectations regarding our new video analytics offering and our other video services; 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 or any other similar statements are intended to identify such forward-looking statements. These statements are subject to risks and uncertainties, including those contained in our updated Risk Factors section of our most recent quarterly report on Form 10-Q filed with the Securities and Exchange Commission and subsequent reports that we filed with the Securities and Exchange Commission from time to time that could cause actual results to differ materially from those contained in the forward-looking statements.

Please note that these forward-looking statements made during this conference call speak only of today’s date, and Alarm.com undertakes no obligation to update these statements to reflect subsequent events or circumstances, except to the extent required by law.

Also during this call, management’s commentary will include non-GAAP financial measures and provide non-GAAP guidance. Management believes that use of these non-GAAP financial measures provides an additional tool for investors to use in understanding the company’s performance and trends, but note that the presentation of non-GAAP financial information is not meant to be considered in isolation or as a substitute for the directly comparable financial measures prepared in accordance with GAAP.

Reconciliations between GAAP and non-GAAP metrics for our reported results can be found in the financial statement tables of our earnings press release, which we have posted to our Investor Relations website at investors.alarm.com. This conference call is also 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.

With these formalities out of the way, I’d now like to turn the call over to Steve Trundle. You may begin.

[Steve Trundle, President and Chief Executive Officer]

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 was $74.3 million, up 20% from $61.9 million in Q3 of 2017.

Our non-GAAP adjusted EBITDA in the third quarter was $25.8 million, up 32.6% over last year. During the quarter, we saw both higher-than-expected account origination and a slightly expanded breadth of services being sold and installed. These strengths drove our better-than-expected results. I want to thank our service providers as well as the Alarm.com team for their contributions during the quarter.

Beyond our financial performance, I also want to highlight some of the recent progress we have made in our product portfolio. We achieved a major milestone with our release of video analytics, which was formally announced just last week. I want to give you an overview of these new capabilities and also update you on the broader development program we've established for ongoing innovation in the fields of computer vision and artificial intelligence.

Our video analytics service is built on object tracking and object classification technology. Object tracking analyzes each frame of video to determine an object's direction of movement and duration of activity. The object classifier identifies people, vehicles and animals. Combined with virtual zones and tripwires, we can now alert subscribers about highly specific events around their property. For example, instead of sending an alert about routine movement or changes in the scene, we can now watch for people lingering near a front door for a specific duration. We can also watch for a pet getting on to a sofa or for kids leaving the backyard. For commercial applications, a business manager can confirm that a delivery truck arrived at the loading dock without being notified each time a customer exits the building.

These insights can, in turn, be used to trigger devices to respond. So if we spot a person entering the backyard at night, we can turn on lights to provide an additional security deterrent. Meanwhile, if an animal such as a deer enters the same area, the user can opt not to turn on the lights but instead to turn on the sprinklers. The combination of our video analytics player with our automation capabilities demonstrates the power of a fully integrated platform.

Our video analytics offering is now available for both existing subscribers and new installs with our popular 522 and 722 cameras, and we'll be expanding camera support over time. The new capabilities are packaged in a new video service plan that includes additional video content storage and is offered for a modest additional subscription fee. We believe that video analytics will generate more value and engagement for subscribers which, in turn, support sales and reduces churn for our service providers. This is the first market release of technology that has been derived from our acquisition of ObjectVideo in January 2017.

Since the acquisition, we developed and deployed a deep learning architecture called a convolutional neural network. To train the system, we use real-world smart home data from video clips captured in the field. This required processing and analyzing millions of frames of video. The result is a proprietary neural network that is optimized for indoor and outdoor applications. As our subscribers adopt video analytics at scale, our neural network will continue to benefit from direct user feedback and from a continual process of training, validation and testing.

Beyond video analytics, we also recently enabled Apple's new Siri shortcuts feature for our subscribers. These capabilities were part of the expanded voice assistant functionality that came with the release of iOS 12 by Apple. Subscribers can now create custom Siri phrases to trigger actions through their Alarm.com system. With our Scenes feature, they can quickly and easily engage their system to adjust multiple devices with a single voice command. This capability allows us to combine the convenience of voice control with the higher value away-from-home use enabled by mobile interfaces like the iPhone.

In October, we held our annual Partner Summit here in Washington D.C. We hosted a number of our service provider partners and presented our latest products and R&D priorities. Overall, the conversations that I had during the summit reinforced that we are well aligned with our service provider partners and presented our latest products and R&D priorities. Overall, the conversations that I had during the summit reinforced that we are well aligned with our service provider partners and what they are seeing in the market. We heard additional positive feedback about the Alarm.com for business platform and we learned about new opportunities that we can address through future product enhancements.

Meanwhile, in the residential market, our service providers continue to see strong demand for a professional grade fully integrated security-first smart home service. We also discussed video analytics and how this new feature set can help increase sales of video services. A number of the initial video analytics use cases are for outdoor applications where we see professional installation as a significant additional differentiator. Our service providers appreciate this alignment, and they see good opportunities for additional growth with video. Our service providers also shared positive feedback on the consumer marketing program we implemented this year.

As I have mentioned before, our message informs consumers that they can turn to a licensed professional for a well-designed and reliable smart home and business system that provides long-term value. We believe these campaigns help our service providers as they market and sell our solutions. It was encouraging to hear feedback from the field validating our approach.

I also want to highlight one event from our Other segment businesses this quarter. EnergyHub expanded its partnership with the Arizona Public Service, the largest electric utility in Arizona. EnergyHub's platform will manage Arizona Public Services full-scale "bring your own device" program which will include a broad range of grid edge devices, including battery energy storage, smart solar inverters, water heaters and connected thermostats. The expanding breadth of connected devices enables EnergyHub to provide increasing value to its utility customers with services like peak demand reduction, load shifting and renewables matching.

Next, I want to spend a moment reminding investors of our high-level strategic framework as we focus on wrapping up 2018 and look into 2019. We remain committed to an adjusted EBITDA margin target range of 20% to 25% and to driving fast recurring revenue. We view hardware as a key enabler of our services, but we are not overly focused on either the amount of hardware sales or the margins of our hardware business. This gives us the flexibility to run discounted or subsidized hardware promotions that drive the adoption of a new service or an upgrade cycle with existing subscribers.

To summarize, I'm very pleased with our performance this quarter and the progress we've made to introduce new products, particularly our video analytics offering. Thank you again to our service provider partners and the Alarm.com team for their hard work and to our investors for their trust in our business.

And with that, let me turn things over to Steve Valenzuela. Steve?

[Steve Valenzuela, Chief Financial Officer]

Thank you Steve. And good afternoon everyone. I will begin with the review of our third quarter 2018 financial results and then provide guidance for the fourth quarter and our raised outlook for the full year of 2018 before opening the call for questions.

SaaS and license revenue in the third quarter grew 20% from the same quarter last year to $74.3 million. This includes Connect software license revenue of approximately $10.5 million for the third quarter compared to $9.3 million for Q3 2017. Our SaaS and license revenue visibility remains high with a revenue renewal rate of 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 $37.6 million, up 34% from Q3 2017 revenue of $28 million. The increase in hardware revenue was primarily due to an increase in sales of our video cameras. We believe approximately 25% of video sales are for existing subscribers as they upgrade to our newer cameras or add video to their systems for the first time.

Total revenue of $111.8 million for the third quarter grew 24.3% from Q3 2017. SaaS and license gross margin for the third quarter was 84.5%, consistent with our gross margin in the same quarter last year. Hardware gross margin was 18.8% for the third quarter compared to 20.5% for the same quarter last year, primarily due to mix. Total gross margin was 62.5% for the third quarter, down from 64.6% for the same quarter last year due to the hardware margins along with the higher mix of hardware revenue.

Turning to operating expenses. R&D expenses in the third quarter were $22.9 million compared to $19.3 million in the third quarter of 2017, as we continued our planned investment in R&D, given the significant opportunities we see in our markets. We ended the third quarter with 496 employees in R&D, up from 441 employees in the same quarter last year. Total headcount increased to 866 employees compared to 774 employees at the end of Q3 2017.

Sales and marketing expenses in the third quarter were $14.1 million or 12.6% of total revenue, compared to $10.4 million, or 11.6% of revenue in the same quarter last year.

Our G&A expenses in the third quarter were $43.7 million which includes a legal settlement of $28 million as we previously announced. Excluding this, our G&A expenses in the third quarter were $15.7 compared to $13 million in the year ago quarter. G&A expenses in the third quarter includes non-ordinary course litigation expense of $5.2 million and the legal settlement of $28 million compared to $1.9 million for Q3 2017. Non-ordinary course litigation expenses are part of our adjusted measures and are excluded from our measurement of our non-GAAP financial performance. Non-GAAP adjusted EBITDA increased to $25.8 million in the third quarter, up 32.6% from $19.5 million in the same quarter last year.

In the third quarter due to the legal settlement, we had a GAAP net loss of $7.7 million, compared to GAAP net income of $15.1 million in the year ago quarter. Non-GAAP adjusted net income increased to $18.2 million in the third quarter compared to $13.3 million for the third quarter of 2017.

Turning to our balance sheet. We ended the third quarter with $124.2 million of cash and cash equivalents. Note, we expect to pay the legal settlement in future quarters. Therefore, ending cash balance had not been reduced for this amount as of the end of September 2018. In the third quarter, we generated approximately $19.8 million of cash flow from operations compared to $13.8 million for the third quarter of 2017.

Our free cash flow for the third quarter was $16.6 million, up $4.7 million from our free cash flow of $11.9 million for the same quarter last year. Through the nine months ended September 30, we generated $25.7 million of free cash flow compared to $30.9 million for the same period in 2017.

Moving to our financial outlook. We expect Q4 SaaS and license revenue of $76.3 million to $76.5 million. We are increasing our expectations for full year 2018 SaaS and license revenue to be between $289.5 million to $289.7 million, up from our prior outlook for SaaS and license revenue of $286 million to $286.5 million. We are also raising our guidance for total revenue for 2018 to $407.5 million to $409.7 million, up from our prior guidance of $388 million to $390.5 million. This includes our increased guidance for hardware and other revenue of $118 million to $120 million, compared to our prior guidance of $102 million to $104 million. We expect hardware revenue for Q4 to be seasonably lower than Q3 consistent with historical trends.

We are increasing our expectations for our expectations for non-GAAP adjusted EBITDA for 2018 to be between $91 million to $91.5 million, up from our prior guidance of $85.1 million to $85.9 million. We are also raising our guidance for non-GAAP net income for 2018 to $63.8 million to $64.2 million or $1.28 per diluted share, up from our prior guidance of $59.4 million to $59.9 million or $1.19 to $1.20 per diluted share. This is based on our non-GAAP tax rate of 21% as we have previously indicated.

EPS is based on an estimate of 15 million weighted average diluted shares outstanding. We expect full year 2018 stock-based compensation expense of $13.5 million to $14 million.

Finally, while it is too early to spend much time on 2019, I did want to provide a very early perspective. At this time, we are comfortable with total revenue of $430 million to $440 million for 2019, in line with current consensus. While we considerably outperformed our own expectations for sales of hardware during Q3, it can take several months for those sales to work in the channel. We anticipate that some of the behavior that led us to raise the 2018 guidance is indicative of future sales patterns. But until we're able to fully track the sale through of these incremental sales, we will remain conservative in estimating hardware revenue.

Also, consistent with our past practice, our guidance does not anticipate the potential for increased revenue from new product introductions such as our recently introduced video analytics service, Alarm.com for Business and our Access Control products, among other items that we believe can drive revenue higher. We will provide our initial guidance for 2019 when we report our fourth quarter 2018 results in February next year.

In conclusion, we are pleased with our performance and excited about the opportunities ahead for us and our service providers. We are continuing to invest in our business to capitalize on the expanding opportunities in both residential and commercial markets for the intelligently connected property.

Thank you for joining us on our call today. And with that operator please open the call for Q&A.

[Operator]

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

[Adam Tindle, Raymond James]

Hi, thanks. And good afternoon. Steve Trundle I just wanted to start with the question on competition. You're seeing even more significant competitive pricing on the DIY channel. Gross margin indicated down 300 basis points year-over-year in Q4 for some in that space. So I'm just hoping that you'd give a general comment on deterioration of that channel. And is there any tie-in to the EBITDA guide for Q4. I know you were expecting it to be up sequentially and mix is improving, but I recognize you just had a very, very strong Q3, so may be some conservatism built in. Thanks.

[Steve Trundle, President and Chief Executive Officer]

Sure Adam. I'll start with that. I'm not sure I caught all the components of the question. But in terms of the competition that we see, each quarter, we see another announcement from someone who's competing with some type of a – typically a point solution, a DIY product of some sort. As we said before, the bulk of our market are customers who view the systems that our service providers provide to be investments in their home, and they really want to have a fully serviced complete system. So we do bifurcate the markets, or we break it into components. And we have not seen any – I guess, I would say almost as evidenced by the third quarter and even the quarter before, we haven't seen a meaningful impact from any of the new competition and the more DIY point solution segment.

As far as gross margins go, I would have triggered shifts in gross margin, and I made a comment on this a moment ago to be more a function of our strategy and the mix of products that we're, at any given point, attempting to get to market with our service providers. So as that mix shifts, or as we see, in some cases, sort of outperformance in one category that we didn't expect, we will see some margin compression. And I almost say that it's not our goal – and I sort of alluded to this, our goal is to get product to our service providers at a price point that works and allows them to drive services out to the customers. So we don't really attempt or we don't get too upset if we're losing some margin from time to time one quarter to another on product. That's part of our business.

So I wouldn't attribute the change, though, to be driven by any sort of external market dynamic.

[Adam Tindle, Raymond James]

Okay. And I just wanted to ask an industry kind of question. Your professional monitoring channel and the high-end home automation like Control4, Cervont, et cetera, kind of two markets growing rapidly in conjunction both with seemingly sizable runways. And you've seen some overlap with both having Toll Brothers' partnerships, for example. Does it make sense, over time, for these two channels to combine, given they're both focused on empowering a Pro installer channel? Just the puts and takes to that.

[Steve Trundle, President and Chief Executive Officer]

Sure. Does it make sense to combine sort of a Control4 Cervont type of channel. That channel's existed for a long time and it is very much a CEA channel. It is a smaller group of customers. These are typically folks that are spending anywhere from $10,000 to $50,000 on a pretty elaborate smart home system. It's driven more – the revenue model there is driven typically more by the devices and the hardware being sold, and it's less about services. So it's a different customer. Our service providers are going after a much bigger part of the market but a bit more of a value-oriented part of the market.

And I think we're focused where sort of I like to be focused, which are on customers in sort of an affordable premium category, and we're not that focused on sort of the really high-end part of the market. We service some of those customers who want the best security they can have, and they may use us in concert with a Control4, with a Cervont , but it's a smaller piece of our business.

[Adam Tindle, Raymond James]

Thank you.

[Operator]

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

[Nikolay Beliov, Bank of America]

Hey guys this is Nikolay from Bank of America. Thanks for taking my questions. Question for Steve Trundle. There seems to be a new trend in the industry with service providers, the hardware financing being down by third parties like banks. Steve Trundle, what is your kind of impression of that? Is it making the industry a little bit healthier? And kind of like how that might impact the business?

[Steve Trundle, President and Chief Executive Officer]

Yes good question Nikolay. So lots of different opinions on that. I'm not sure mine is any more valuable than others, but my personal opinion is that it's a healthy dynamic for the industry. Anytime you have the customer, we've always said, and all of our service providers have told us for a long time, that if a customer makes an investment in their system upfront, that those are typically better customers than customers who received the system for free and now are basically repaying for the upfront capitalization cost in the form of their monthly service bill. So we like a mix. We like to see customers that are invested up front. We think that the financing piece, if I were to spend $5,000 on my system in my own home, I could choose to finance that anyway and dealers are now increasingly making that financing more available and easier to sort of obtain for the consumer.

I think that allows the service provider or the dealer to offer a wider range solution of the consumer. It's more likely to meet their complete need. I think that probably generates some downstream value to us and that the customer – if we roll the clock back 10 years, the typical customer might only have a handful of intrusion sensors in a control panel. And if you try to sell that same system today, there still is a market for it, but it's a much smaller market. The majority of the folks want to have a more powerful system that includes intrusion and includes some level of smart home functionality and cameras. So there's just a higher upfront cost, and that cost has to be borne by someone, either the service provider or the customer or potentially the customer through a financing mechanism.

So I think that the financing element makes it more attainable and more possible for our service providers to sell a complete system to a customer without sort of wrecking the balance sheet by basically giving away a much bigger system today for free than what they may have needed to do 5 to 10 years ago.

[Nikolay Beliov, Bank of America]

Got it. And Steve, a question commercial. Our conversations with partners indicating really good initial traction, especially around access control. So how can you convince the channel and customers to buy not just the access controls, I guess, which sign with other third-party hardware but like more of the video plus interactive security plus access control?

[Steve Trundle, President and Chief Executive Officer]

Yes, good one again. So yes, we're seeing great feedback on access control. I commented on that a moment ago. I think last quarter, I indicated we had gotten an initial set of about 150 service providers set up to be early adopters. And again, promoting that product in the market, that's gone up during the third quarter, so we're continuing to see some adoption.

And really in terms of getting the holistic systems sold in, first, I'd say there are some cases where access control by itself is fine or commercial by itself is fine or even video by itself, but we obviously, prefer the system, those systems where the customer has the benefit of all three technologies. And I think for us, somewhat of a missing part was really an upgrade of our video platform. So it's been acceptable, but I think this quarter, I spent a lot of time talking about what we've done with video. In prior quarters, I talked about the cameras. This quarter, I talked about really the software. And I think until the third quarter and some of the capabilities we got to market, we weren't as competitive with the video offering, especially on the commercial side as we would like to be.

So not only we sort of put a stake in the ground there, and I think anyone – and we're now looking forward to building on top of that. And I think that someone obtaining that access control system today would be impressed, I should say, with the video solution that can be sold with it. So I think some of it will – some of that, what you're describing Nikolay, will happen as the product is compelling. And I think it now is in a more compelling state than we probably were three to six months ago.

[Nikolay Beliov, Bank of America]

Thank you.

[Operator]

Our next question comes from John DiFucci with Jefferies.

[John DiFucci, Jefferies]

Thank you. My question – well, first of all, the results are really strong here. And I'm just trying to understand like where that's coming from. Is it coming from the core traditional alarm business? Because you guys have instituted investments in other areas like in the commercial business, in international? Are we starting to see that in these numbers? Is that what we're seeing? Or is that still yet to come? Are we seeing much of that at all in these numbers? Or are we just seeing the core business doing well right now?

[Steve Trundle, President and Chief Executive Officer]

Yes. I would say that the results, to the extent they're beyond our expectation, were driven more by the core business, the service providers, who are effectively selling to the consumer and Alarm.com more traditional intrusion system just because that today is a bigger part of the business, meaningfully bigger. So if that doesn't do well, other – it's hard to make up for a gap there.

And when we see some outperformance there, it causes a more extreme result than normal. That's not to say the other parts aren't doing their share to contribute and aren't growing nicely, that meaning commercial, international pieces as well as EnergyHub is doing well. That's why I highlighted one of the recent deals.

They're all doing well, but on a relative basis, their size is not sufficient to be the cause of a – at the current moment, and we hope this evolves. At some point in the future, each of those initiatives could outperform and drive a great result. But at the moment, none of them are at a sort of level of scale that they can nearly by themselves impact the overall quarter the way sort of third quarter came around.

So third quarter was just – partners aren't selling more systems than we expected. They're putting a little bit more on those systems, particularly more video, and they had a good quarter, the service providers did for the most part. So that was the real driver there.

[John DiFucci, Jefferies]

Thanks, Steve. And if I might just one follow-up. And I don't know how much you could say about this, but it's more of a tactical question. See, you had a settlement with one of the plaintiffs from the class action suit and there's a some concern that – I mean that's just one of the plaintiffs that, that could be just the beginning of it. Is there anything you can talk to us about whether that was unique? Or I mean you never know what's going to happen, but you obviously settled that at this point.

I'm just trying – we're just trying to understand the risk that you end up settling with a lot more because you can have the business doing as well as it's doing, and then as an investment, you have to weigh against some of these other things.

[Steve Trundle, President and Chief Executive Officer]

Right. Yes. That's a good question, John. I think if we were worried about that – I can't say a lot about that particular case obviously. I can kind of put you in a frame of mind, though, which is if we thought that were going to be a repeating phenomenon, we would be pretty reluctant to settle it. So that's the frame of mind I would probably suggest is – and then I would encourage you to basically when the 10-Q is up to give that a real careful read in the section related to legal and outstanding matters because there are no other current pending PCP matters of that nature.

[Steve Valenzuela, Chief Financial Officer]

One other pending matter was dismissed last week. You'll see that on the 10-Q that's actually filed. It's available online.

[John DiFucci, Jefferies]

Okay. Okay, great. That’s all very helpful. We’ll look – we’ll review that closely. Thanks a lot guys.

[Steve Trundle, President and Chief Executive Officer]

Thanks, John.

[Operator]

Our next question comes from Matt Pfau with William Blair.

[Matt Pfau, William Blair]

Hey, guys. Thanks for taking my question. I wanted to follow up a bit on the 2019 guidance, and Steve your sort of comments about perhaps some hardware sales that might have actually occurred – might actually occur in 2019 to the end consumers being purchased from you in 2018. And so if I look at the initial 2018 guidance you gave for hardware, you're forecasted to come in about $20 million or so ahead of the high end of your initial guidance.

So is that how we should – should we think about that differential as of the amount that's pull-forward from 2019 to 2018? And then, I guess, as we think about the coupling or decoupling of hardware growth relative to subscription revenue going forward, why should hardware start to materially grow slower than subscription revenue?

[Steve Valenzuela, Chief Financial Officer]

Yes, this is Steve Valenzuela. So I think a couple of points there. First of all, keep in mind that Q3 and Q2 are seasonally stronger than Q4. And so when you look at the guide for hardware for Q4, just take into account seasonality. But also with Q3, we did see a very, very strong performance in video, and very encouraging to see video – about 25% of those sales going to existing subscribers.

But as I said on my remarks, we just need to be cautious that if some of that was perhaps pull forward from Q4, obviously, there's a lot to of macro events occurring with potential trade wars and tariffs. So there could have been some activity or pulling some of that forward. That said, I think there is anecdotal information that we're seeing a very positive uptick in hardware.

But when we look five quarters out, when we look at 2019, we're – we have to be fairly cognizant of a lot of things that can change. And as Steve said, we need to use hardware. Given that we have a very good recurring SaaS revenue and very good margin, we use hardware strategically, so we're going to maintain that flexibility. So when we look at 2019, again, this is very early. And we just wanted to be careful, given the strong performance in Q3, we didn't want folks to get ahead of themselves.

But the way we were kind of thinking about 2019 with the guide, it's not the guide, but the initial look. Let me clarify that, it's not a guide. We're really thinking kind of, from our mind, hardware would look lower in 2019 than it was in 2018. Now that could actually not turn out to be the case, but we just have to be careful given that hardware's not reoccurring, given that there's a lot of macroeconomic events occurring. When we're looking at that part with an initial look, we still have to grow through our budgeting process in our cycle, we just have to be cognizant, careful when we're putting a number out there that far out in advance.

[Matt Pfau, William Blair]

Got it. And then if I think about 2018 relative to your expectations in 2019, it sounds like a decent amount of the outperformance in 2018 was due to video camera sales. And now with video analytics functionality, that is a driver to perhaps encourage even more uptake of video which, in turn, would potentially drive more sales of your video cameras. So is that the proper way to think about that potential? Or is it the fact that maybe this video analytics is going to be integrated and used with other third-party cameras that you don't provide and, thus, there won't be a correlation from a hardware revenue perspective.

[Steve Valenzuela, Chief Financial Officer]

No. I think – I mean we just introduced video analytics which we're quite excited about. It's a very great offering focused really on a lot of SaaS capabilities. But in terms of hardware, what we said was when we talked about 2019, our practice when we give initial look to our guidance is not to include the potential upside for new product introductions.

So video analytics, we just released a week ago. We really can't factor that into our initial look or guidance just yet, and – so that's kind of how we – has been our standard practice, and it's – I think it served us well so far. But I think it certainly is a great offering, very compelling and we'll see how the adoption comes through from our service providers. But the feedback both Steve said on the Partner Summit we had in October was very positive from the service providers as well.

[Matt Pfau, William Blair]

Great, that’s helpful. Thanks a lot guys. I appreciate it.

[Steve Valenzuela, Chief Financial Officer]

Thank you.

[Steve Trundle, President and Chief Executive Officer]

Thanks, Matt.

[Operator]

Our next question comes from Gabriela Borges from Goldman Sachs.

[Gabriela Borges, Goldman Sachs]

Good afternoon and congrats on the quarter. This is more of a macro question for Steve Trundle, which is how sensitive do you think your business is to the housing market. Just wondering what you're hearing from the dealers on the ground in terms of new customers coming to the platform because they've moved homes or because they bought a new home for the first time versus maybe upgrading as part of their renovation budget or for some other reason. Thank you.

[Steve Trundle, President and Chief Executive Officer]

Right. No. I think we've lived through a few housing cycles, and in the last one sort of the 2008-2009 time frame, we really weren't impacted by the negative housing cycles. So – but the business was a little less mature then. The theory and what we've learned from our service providers is that in a negative economic cycle, the desire for protecting what you have tends to go up, and folks are a little bit more focused on getting an intrusion system because they're seeing people hanging around the neighborhood. It might not be working, that sort of things.

So it tends – there tends to be some positive effects, unfortunately, from a – let's say, some offsetting effects from a negative housing cycle if that is driven by negative or bad economy. I'd say we're a little bit more exposed at this point, though, than we were six or seven years ago because we have a healthy – we have a fairly healthy program now with builders, and we like to see them doing well. And then in terms of how that cycle's going to unfold, I think our view is there's still quite a bit of room for growth in the housing market.

But I wouldn't say it's going to – we're not enormously volatile there, but I would say that it'd probably be more noticeable if we had a negative cycle today than it might have been for us seven, eight years ago.

[Gabriela Borges, Goldman Sachs]

That’s very helpful, thank you. And then follow-up is on the hardware piece of the business. To the extent you can disclose, what percentage of that mix or even qualitatively is video cameras versus maybe other things like modems or thermostats? And just remind us what that – the composition of that line item looks like? Thank you.

[Steve Trundle, President and Chief Executive Officer]

So rough composition, and I don't have the data breakdown in front of me. But rough composition is about half of the hardware revenue component is video or video cameras. And the other half would be a mix of thermostats and module sales, which is the LTE of the modules, maybe a couple of other smaller items in the other, but primarily, thermostats and modules and then the rest would be video, 50%.

[Gabriela Borges, Goldman Sachs]

That’s very helpful. Thank you for taking the questions.

[Steve Valenzuela, Chief Financial Officer]

Thank you.

[Steve Trundle, President and Chief Executive Officer]

Thank you.

[Operator]

Our next question comes from Saliq Khan with Imperial Capital.

[Saliq Khan, Imperial Capital]

Hi, guys. Just a couple of quick questions on my end. We would see – with the launch of the video analytics, is it essentially the first step towards you guys being able to provide professional verification for the dealers? And how would you envision that playing out for the marketplace? And is it too early for us to kind of think about data analytics for monitor alarm or event verification?

[Steve Trundle, President and Chief Executive Officer]

Thank you for the question. So we already do, Saliq – so video verification is already a part of our value proposition and a number of our service providers make use of the video cameras already. In the current dynamic, if there is an alarm event, the service provider determines that time of installation, how that will be handled. And if the customer is comfortable with the video from the cameras coming to the central station during the event, then that is turned on. That helps the operator adjudicate the matter and make a decision on how to handle the alarm. So that's been there for some time.

And in terms of video analytics impacting that, I think this would be a step – what we're doing now would a step towards a couple of things, first, potentially driving events to the central station that are not necessarily alarm events but that are still noteworthy events. We can increasingly drive intelligence from video to identify other things of interest that may be of interest to the consumer or business owner and may prompt a central station monitoring activity.

We may also be able to more effectively provide the operator, the person to headline the decision, of whether or not dispatch, provide that operator with more insight into the events that they're actually trying to make a judgment on. So if we see something that is routine, we may at least want to notify the operator that everything looks routine. But for an alarm event that came off by the given intrusion sensor.

So I think there will be richer data sets that we can derive with video analytics, and I think it's been in our interest and in the interest of our service providers for us to make use of those data sets as much as possible with the consumers' consent and still protective of their privacy but to make use of those data sets to improve the efficacy of the decision on whether it is to dispatch or not with the first responders.

[Saliq Khan, Imperial Capital]

That's very helpful, Steve. And then just a follow-up on my end, we're seeing an increased amount of conversations with the insurance providers out there, some of the utility providers and then more meaningfully for the traditional security industry, the SMB market that has traditionally been okay from a security perspective. There's a very large runway ahead for these guys. So could you highlight your plans for helping upgrade those SMB customers to more integrated and advanced analytics? And then my thought process is advanced analytics are eventually more business analytics solutions as well. How are you guys thinking about that?

[Steve Trundle, President and Chief Executive Officer]

Right. So we're turning our focus to that sort of in real time. I think our first goal with analytics was to get a solution out that would work for a broad range of customers, including residential and commercial, and would solve the most common use cases. But when we look at SMB in particular, there's an opportunity to drive down different verticals that have slightly different types of analytical templates and be even smarter.

So for example, a store is going to look a little different than a bar and a restaurant and the types of things you're observing are going to be different, the types of accounts you're doing are going to be doing. And then the way you integrate with the point-of-sale data in that case can be different between those two different types of SMB location.

So we're – I guess I should say shifting now to sort of what the next- gen opportunities are with the analytics layer. And here, I think, we're, at the moment, listening to our service providers. First and foremost, what are they seeing as the opportunity set, what's not being currently addressed at an effective level in the market and beginning to derive where we're going to go with some more specifics sort of vertically-oriented analytic templates for the SMB market.

[Saliq Khan, Imperial Capital]

Great. Thank you, Steve.

[Steve Trundle, President and Chief Executive Officer]

Thank you.

[Operator]

Our next question comes from Darren Aftahi with ROTH Capital Partners.

[Darren Aftahi, ROTH Capital Partners]

Hey, good afternoon. Thanks for taking my questions and congratulations. Just two, if I may. Just first back to analytics. So Steve, you talked about the convolutional neural network. So I'm sort of curious. When you think about long-term differentiation with video analytics and data analytics in general, like there are other solutions out there that have been trained on video images, et cetera. Like how do you differentiate the product long-term? And then embedded within that question, we use that as kind of lead gen to differentiate the product.

My second question to Steve Valenzuela. I know you had talked about increasing marketing spend, and that was up pretty substantially year-on-year. I'm just kind of curious if you under spent relative to plan on 3Q. Thanks.

[Steve Trundle, President and Chief Executive Officer]

Sure. I'll let Steve take that second piece. It's right up his alley. And the first piece is differentiation in video analytics. I have opinions on this that I'll cover. First is there's a real scale advantage. And when you're driving a neural net and you're training that AI engine, the more, the better. The more information and content you can feed it, the smarter it becomes. So there is a scale that we think we're reasonably well positioned to take advantage of, maybe not against every competitor but against the majority of the folks.

The second is we're focused and always have been on trying to take cutting-edge capabilities and make them fit an economic envelope that still works for the average sort of affordable premium type of customer. And in this case, if we look at our acquisition of ObjectVideo, a lot of what we rolled out are capabilities that they've done a decade ago almost, got it a little differently.

But the real challenge was figuring out how to make that technology work without a ton of compute on the edge and with a modest amount of sort of supplemental commute – compute in the crowd such that we can price it at a level that is affordable for the average even residential consumer. So that's a place for today I think as of right now, we have an advantage, and we will stay focused on maintaining that advantage. Of course, the cost of compute on the edge will steadily come down, but that's the focus.

The third is more interesting – a lot more interesting but a more – a different sort of level differentiation, which I think is going to come from the business model of the companies who are involved in providing the capability. And what I mean by this is our business model allows us to be very transparent with the customer on how we treat their information and how we protect their privacy. We don't need to take metadata from a video analytics layer and push that in to our marketing database or any other database that we may maintain on the consumer.

I think some of the other folks that are potentially in the market can't make that same commitment to the consumer and still have a viable business model. So I think that can actually be – the third part is trust. And you operate long enough and you do well by the consumer and hope that their trust in our approach would become a third-level differentiation. I'll leave the second piece for Steve.

[Steve Valenzuela, Chief Financial Officer]

Hey Darren, the question on the marketing. So the marketing spend for Q3 was actually about 12.6%. At the beginning of the year, we did say we expected marketing to be around 14% to 15% of revenue. And so we're pretty much right on track. Another thing to think about, too, is Q4, we do have in October our annual dealer – national service provider conference in Washington D.C., which does increase the marketing spend a bit in the fourth quarter. But I would say from a planned point of view, we're right on track with the marketing spend, as we laid out at the beginning of the year.

[Darren Aftahi, ROTH Capital Partners]

Helpful. Thanks.

[Steve Valenzuela, Chief Financial Officer]

Thank you.

[Steve Trundle, President and Chief Executive Officer]

Thanks, Darren.

[Operator]

Our next question comes from David Gearhart with First Analysis.

[David Gearhart, First Analysis]

Hi, good afternoon, thanks for taking my questions. First question I wanted to ask, you mentioned in your prepared remarks that the video analytics offering would be a modest increase in pricing. Just wondering if you can give us some sense of how much of an uplift it would be on a per-subscriber basis, on the analytics piece itself and on the storage side.

[Steve Trundle, President and Chief Executive Officer]

On the analytics piece and on the storage, okay. Well, that's two parts actually. They're very related, which is we have wanted to introduce this in a way that we think it is conceivable for our service providers to offer it at a modest additional sort of rate to the consumer. And what we've included – our typical today basic video plan is – includes 30 – roughly 30 clips of storage per day on up to four cameras. That's our plan today, and that does not include video analytics.

And we're not getting rid of that plan. So we're not going to sort of drop out of that market. That's probably the most sort of price competitive part of the market. We want to keep our entry-level offering available there. With this offering, we're including 100 clips per day for each property on up to four cameras in aggregate. So we're tripling the storage that comes with the plan that includes video analytics, and then we're including the analytic capabilities that we've currently released.

And the incremental cost, there's sort of what's the consumer is going to pay and what do we expect. I think our expectation, I don't want to get into a ton of detail because I want to leave our service providers a lot of freedom to place how it makes sense for them. But our expectation is that the incremental revenue to us from one of these would be roughly an extra $1, $1.5 per month.

[David Gearhart, First Analysis]

Okay, that’s helpful. And then just wondering if you can give us a quick update on international and what you're seeing there in terms of traction and trajectory.

[Steve Valenzuela, Chief Financial Officer]

Yes. International is – I think I spent a little bit of time on that last quarter, and at that time, I think we said we were up to sort of in the 37 different countries with service providers. And kind of moving along, I don't think much changed. The momentum on international is about the same. Let me see if I have anything – growth is healthy, but still sort of early days.

In the third quarter, I think we're getting to the point where more of our partners internationally where we're sort of shifting from testing, pilots and early sort of efforts to sort of getting to the point where folks are really beginning to institutionalize what we do into their offering. I expect that will continue to drive uptake on international. Particularly, there are some markets that are a little more mature. But particularly when I look at Europe as an example, I think we're kind of on the cusp from a shift that will be positive.

The big thing was the announcement with the insurance company, though, with Aviva last quarter and just generally seeing positive trends there, but haven't focused on it as much this quarter.

[David Gearhart, First Analysis]

Okay. Sounds good. Thank you so much.

[Steve Valenzuela, Chief Financial Officer]

Thanks.

[Steve Trundle, President and Chief Executive Officer]

Thank you.

[Operator]

And the next question comes from Nehal Chokshi with Maxim Group.

[Nehal Chokshi, Maxim Group]

Yes, thank you. You mentioned that the lower hardware GM was due to mix. Presumably, that's due to video cameras, correct? And therefore, has that been driving ARPUs higher and that's a big part of the strong SaaS growth that you've been reporting?

[Steve Valenzuela, Chief Financial Officer]

So part of the margin impact in the quarter was increase in modules as well, which does have an impact on margin. So there were more module sales in the quarter. But then also, as we talked about, there were more sales of video, and there's a mix of different video cameras as well with different margins as well. But you're right, generally, with the video service, generally, there is an uptick in SaaS. I just want to be cautious in terms of how that plays out exactly, but…

[Nehal Chokshi, Maxim Group]

Okay.

[Steve Trundle, President and Chief Executive Officer]

No, that’s fine if that would make it work. But Steve's key point is there were quite a few module sales as well in the third quarter and those are sold normally through an OEM channel where we sell to another manufacturer who then resells to the service provider. So those are typically at pretty thin margins.

[Nehal Chokshi, Maxim Group]

Okay, understood. So just to be clear then, that percent of hardware sales that's going to video is increasing on a year-over-year and Q-over-Q basis. Is that correct?

[Steve Valenzuela, Chief Financial Officer]

That’s correct. Yes.

[Nehal Chokshi, Maxim Group]

Excellent. Thank you.

[Steve Valenzuela, Chief Financial Officer]

Yes.

[Nehal Chokshi, Maxim Group]

Go ahead.

[Steve Valenzuela, Chief Financial Officer]

No, I think that's correct. I would say any given month there can be variability. It depends on where the orders come in. But on a trend line basis, that is true.

[Nehal Chokshi, Maxim Group]

Okay, great. Thank you.

[Steve Valenzuela, Chief Financial Officer]

Thank you.

[Operator]

Ladies and gentlemen, this does conclude the Q&A portion of today's conference and the conference call itself. Thank you for your participation. You may now disconnect and have a wonderful day.